CAP Rate is one of the most important indicators, if not the most important indicator, for real estate investors to evaluate deals. What CAP Rate gives us is an unbiased view when comparing properties side-by-side. To begin, let’s start off with the formula:

CAP Rate = NOI / Property Price

As you can see, the formula is relatively simple, there are only 2 elements: The first element is the NOI, or Net Operating Income, has already been covered by our previous blog post here. Then, the second element is the Property Price, which is a loosely-defined placeholder for you to put in some type of a property price. Usually, you would put in its Offered Price or its Appraised Value. The important thing to remember is, whichever you put in, you stick with that same type, in order for you to be able to compare apples-to-apples.

A very important key point about CAP Rate is that it does not take debt into consideration. This means when you compare your investment with your friend’s investment, neither of you need to know whether the other purchased with financing or cash or borrow from parents, simply by using CAP Rate you can effectively communicate how the deal measures with the other. The rule of thumb is simple: The higher the CAP Rate, the sweeter the deal is.

Once you familiarize yourself with the concept of CAP Rate, not only will you be able to evaluate and compare opportunities quicker, but also it will be a stepping stone for you to deploy other advance concept, like force appreciation, more comfortably. The concept of forced appreciation will be covered in a future blog post.

In addition to CAP Rate, there are other key indicators that any real estate investors should learn about. Reading is always our friend. If you are interested, pick up this book from Amazon, because it helped us a lot too.