What’s A Good Cap Rate for a Rental Property?

Q: Gerald, my wife and I are looking at rental properties to buy. What’s a good cap rate for a rental property? Doug, Little Falls, NJ

A: Great question. Let’s start by defining what cap rate (capitalization rate) is. A capitalization rate is the percentage of return from an investment when you divide the Net Operating Income (NOI) by the price you are paying for the property. Cap rates do not consider the costs of financing into the investment equation and in my opinion cash-on-cash return is a more useful statistic for a real estate investor. But since some buyers use financing and some buyers pay cash, cap rates are used more often because it allows you to make an apples to apples comparison from investment property to property regardless of debt service.

Like most things in real estate, cap rates vary from local real estate market to market, so the average cap rate will vary from market to market and neighborhood to neighborhood. My suggestion is that you is to not get preoccupied with average cap rates in your area, and even if cap rates are lower on average in your local market, as a buyer, you always control the offers you make and the amount of money you’ll actually spend, so don’t think about cap rates based on the price a seller is asking for an investment property–it’s better to focus on the cap rate that would result from the offer price that you (the buyer with the money) makes to purchase the property.

Thanks for your question, Doug, good luck.

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