How to figure Cap Rates

Many people get baffled when it comes to figuring out cap rates. Well to compound the confusion there are two areas of finance where we the term cap rates is used. Below i will detail both uses of the term and try to explain how they can be used to benefit you.

The first and most popular use of the term cap rates is used to describe a certain type of mortgage loan. These are regular variable interest rate loans that simply just have a cap on how high the interest rate can go during the life of the loan. They allow you to benefit from any falls in future interest rates while at the same time limiting your financial exposure to any future rises. Following the recent big cuts in interest rates around the world now may be a great time to get a cap rate mortgage.

The second use of cap rates applies to the commercial real estate sector. It can be notoriously hard to distinguish between real estate investments as two properties can vary in so many ways. The cap rate is an equation that aims to show quickly what the return is. To calculate the cap rate on a property simply take the expected rental income less any expenses (such as agent fees or maintenance) and divide by the price of value of the property.

The figure you get can be treated as a return on equity number. You can also use this to some extend to compare a real estate investment with a regular financial investment such as a fixed income bond or a deposit account investment.

As can be seen above Cap Rates are easier to understand than you thought!