How to calculate Capitalization Rate (Cap Rate) for Real Estate

Real estate investors require a reliable method to assess the value of a property they intend to purchase. The most accurate approach involves evaluating the property's actual operating income and comparing it to the purchase price. By determining the capitalization rate and applying it to the property in question, the current value can be determined based on its income.

Here's a step-by-step breakdown:

  1. Determine the purchase price of your real estate investment, such as a short-term rental. Example: STR Purchase Price = $850,000

  2. Calculate the net operating income generated by the property owner. Example: Net Income (after expenses) = $42,500

  3. Divide the net operating income by the property's purchase price to obtain the capitalization rate. Example: $42,500 / $850,000 = 0.05 or 5% (Cap Rate)

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