In the real estate market, you cannot do without a calculator, and you have been able to see this more than once while reading our blog. Together with us you learned to calculate cash flow, that is, the net profit after renting out the apartment, you know how to determine ARV(After Repair Value) and banal yield. It is time to calculate the percentage of capitalization. Before you reach for a calculator, we suggest you add this new term to your real estate slang and understand its components.
❝Cap rate is an indicator used to assess potential returns and risks when investing in real estate.❞
How to calculate capitalization? We will return to this question a little later, but for now we suggest to understand why it is necessary to define it at all and what it gives us. The capitalization rate, first of all, helps to determine the potential of a specific object and the risks associated with its purchase. Comparing the chosen apartment or house with similar offers on the market allows you to make an informed decision and buy a really profitable object.
The percentage of capitalization gives an idea of several characteristics of the object at once. The larger it is, the greater the potential return, but with it, the risks also increase. Accordingly, a lower percentage indicates a lower yield, but gives more guarantees and stability. Only you can choose which vector is closer to you. Before making a final decision, be sure to consult with a real estate expert to get sound advice based on market analysis and forecasting future trends.
Finally, let's move on to mathematics. To calculate the percentage of capitalization, you need to know only two indicators: the value of the object and the net operating income (Net Operating Income, NOI). Net operating income is your net annual rental income. That is, it is worth subtracting mortgage payments, taxes and other incidental expenses from income. The formula for calculating capitalization is as follows:
(Net operating income : Cost of the object) × 100% = Capitalization
Let's take it as an example one-room apartment in Pechersk. Its cost is $110,000, and the rental price will be approximately $1,300/month. Let's set aside $2,000 from your total annual income of $15,600 ($1,300 × 12) for force majeure and mandatory payments. In this case, you would have a net operating income of $13,600 ($15,600 - $2,000). So, let's move on to the most interesting part - calculating the percentage of capitalization:
($13,600 : $110,000) × 100% = 12,36%
This is a fairly high percentage, which indicates the good profitability of the apartment. Regarding the possible risks, they are also quite high, but there is one nuance. For example, we chose premium real estate, and it is always more reliable and stable compared to other segments, so you should not be afraid of potential failure.
Example of use:
- Volodka, you look somewhat preoccupied.
— I just can't decide if I should buy it office space, which I liked so much.
— Then calculate the percentage of its capitalization to make it easier. So you will understand how profitable and reliable this investment will be.
- And indeed! Thank you for reminding me about this indicator, otherwise I was daydreaming and completely forgot about real things that are so easy to determine.
Don't be like Volodka - contact us and leave all doubts in the past. We will also select an office for comfortable work, and dacha near Kyiv we will find a place to grill kebabs.
