Unexpectedly Intriguing!
July 18, 2006

Harrison Loke of Finandom recently reviewed an article by Otesa Middleton Miles on the Bankrate.com web site, which looked at the math that real estate investors should do when making investment decisions. The math behind determining a property's capitalization rate caught our eye and has inspired our latest tool!

The capitalization rate for a real estate investment property is the ratio of annual net rental income received for the property divided by its purchase price, which is expressed as a percentage. It's useful in that it allows an investor to compare potential real estate investments by property values independently of how the financing for the properties being considered would be structured (amount of down payment, interest rates, closing costs, etc.)

Here's the data you'll need to use the tool:

  • Annual rental income.
  • Annual operating expenses (not including mortgage payments.)
  • The property's purchase price.

And that's all! Here's the tool:

Real Estate Investment Data
Input Data Values
Annual Rental Income ($USD)
Annual Rental Operating Expenses ($USD)
Property Purchase Price ($USD)

Net Rental Income and Capitalization Rate
Calculated Results Values
Net Rental Income ($USD)
Capitalization Rate (%)
Years to Recoup Property Value at Constant Rent Level

How To Use the Capitalization Rate as an Investor

The article quotes real estate investor Doug Crowe for how an investor would use this information:

If you're selling a property, says Crowe, "It's better to have a buyer willing to accept a lower cap rate. But if I'm buying, I want a high cap rate." For instance, if you buy a property with a cap rate of 8 percent and did nothing to it but raise the price, the cap rate drops to 7 percent. You've made a profit.

The article notes that capitalization rates of 7-8% are common in the midwest region of the U.S., while 6% is common on the coasts.

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