I hear people talking about CAP rates a lot. What does that mean?

CAP rates are primarily used to sort investment income properties. The CAP (capitalization rate) rate uses the first year net operating income (NOI) divided by selling price to determine a CAP rate. Net operating income is income collected minus any expenses to operate the property, excluding mortgage payments. Example: $60,000 income minus $10,000 expense equals $50,000 NOI or $50,000/$500,000 selling price = 10% CAP rate. CAP rates can then be used to evaluate the property if it is determined the rate is acceptable to current market rates. Of course, there are many other variables that make a good property, like location, age, appearance, deferred maintenance etc. That’s why CAP rates should only be used to sort for the best selections which should be analyzed further under additional criteria.

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