What is a cap rate in real estate?

Cap rate, or capitalization rate, is the ratio of a property’s net income to its purchase price. It’s an essential number for gauging a property’s rental income potential. Many new real estate investors, for instance, assume that as long as their renters are paying more than their mortgage on the property, they’re golden. But that’s not the case.

What is a good cap rate?

A good cap rate hovers around four percent; however, it is important to differentiate between a “good” cap rate and a “safe” cap rate. This is because the formula itself puts net operating income in relation to the initial purchase price. Investors hoping for deals with a lower purchase price may, therefore, want a high cap rate.

What is a good cap rate for a rental property?

As one might expect, the higher the cap rate, the better. For most investors, 4% is the bare minimum they’ll consider for a rental property. Any less, and an unforeseen circumstance (e.g., a long period without tenants or an HVAC problem that leaves the home uninhabitable for six months) could quickly put you in the red.