Capitalization Rate

One of the first equations you will come across in real estate investing is Capitalization Rate (CAP Rate). The CAP Rate simply looks at the potential return of the investment. The higher the percentage, the larger your return. In its simplest form, it looks at the ratio of gross yearly income generated divided by the cost (value) of the property:




Example:
For instance, if we located a $310,000 property that was expected to generate $2100/month in rent, our gross CAP Rate would be:


Real estate investors use the CAP Rate in a similar manner in which stock investors use the P/E Ratio*. These formulas allow for basic, quick calculations to be made to help a person quickly determine if an asset is priced at an attractive valuation.

On the surface, a company sporting a P/E Ratio below 10 usually looks to be cheap. Similarly, a CAP Rate of over 10% will look to be a good deal.