Calculating Cap Rates & More!
In real estate investing, many terms and abbreviations are used and those relating to your return on investment (ROI) are possibly the most important to understand. Experienced investors generally know how to calculate things like capitalization rate (Cap Rate) and cash-on-cash return, but for those who are not quite sure, here is a review.
CAP RATE:
The Cap Rate is the net income (expressed as a percentage) which a property is expected to generate. It is calculated as follows:
Starting with the monthly rent, subtract the monthly proportionate amounts for all direct expenses. These are:
- Property Management
- Property Insurance
- Property Taxes
We also recommend calculating and setting aside contingency amounts for:
- Maintenance (we use 5% of rent)
- Vacancy (we use 7% of rent)
After subtracting these amounts from the monthly rent, you are left with the monthly Net Operating Income (NOI). Multiply this figure by 12 to arrive at the annual NOI. To calculate the Cap Rate, divide the annual NOI by the gross purchase price.
Price $55,000
Renovation $29,000
Total All In $84,000
Rent $900/mo
Property Mgmt (10%) $90
Insurance $44
Taxes $75
Maintenance (5%) $45
Vacancy (7%) $63
Total Expenses $317
NOI per month $583
Cap Rate 8.33%
CASH-ON-CASH RETURN:
Cash-on-cash return is the rate of return (expressed as a percentage) that calculates the income earned on the CASH INVESTED in a property. It is calculated as follows:
Starting with the monthly rent, subtract the monthly proportionate amounts for all direct expenses. These are:
- Property Management
- Property Insurance
- Property Taxes
We also recommend calculating and setting aside contingency amounts for:
- Maintenance (we use 5% of rent)
- Vacancy (we use 7% of rent)
In addition to the above, you also deduct your monthly mortgage payment (we estimate in this example an 80% mortgage for 30 years at 4% interest)
After subtracting these amounts from the monthly rent, you are left with the monthly Net Operating Income (NOI). Multiply this figure by 12 to arrive at the annual NOI.
To calculate the Cash-On-Cash return, divide the annual NOI by the NET CASH OUT OF POCKET used to purchase the property. This is made up of three components:
- Down Payment (often 20% for single family properties)
- Closing Costs (roughly 3% of total purchase price)
- Finance Fees and costs (roughly 3% of the loan amount)
The resulting figure will be your Cash-On-Cash Return.
Price $55,000
Renovation $29,000
Total All In $84,000
Rent $900/mo
Property Mgmt (10%) $90
Insurance $44
Taxes $75
Maintenance (5%) $45
Vacancy (7%) $63
Mortgage Payment $321
Total Expenses $638
NOI per month $262
NOI Annual $3,144
Down Payment (20%) $16,800
Closing Cost (est) $2,520
Finance Fees (est) $2,016
Cash-On-Cash Return 14.7%