Two of the key metrics that real estate investors look for in a property are cap rate aka capitalization rate and cash-on-cash return. In order to bring more value to what we do, we've decided to crunch some numbers and add this data to our ranking lists. Now you can save even more time and make an even more informed decision. Of course we never offer investing advice at Real Estate Ranker, but we do present lots of data in a useful format in order to help you during your search for a property.
What are Cap Rate and Cash-on-Cash Return?
Cap rate refers to the rate of return for a given property. A simplified look at the calculation is NOI or net operating income divided by current market value multiplied by 100. The hard part is determining the NOI because you'll need to know how much rent you can collect and what your expenses are.
Cash-on-cash return is basically annual cash flow divided by the upfront investment to purchase the property(down payment, closing costs, repairs, etc.). It's a metric used to look at potential profitability. It tells you how much money you can make for each dollar invested. The key difference between cash-on-cash return and cap rate is that cap rate does not include mortgage payments in the equation. It's just looking at the operating income —what it takes in and gives out to operate the property.
Now that you know what these metrics are, you may be wondering how we arrived at our cap rate and cash-on-cash return numbers given the wide variation in how people finance, how much rent they collect, how much money down they put on their property, etc. Well, we had to make some assumptions in order to populate our equations and get our final numbers. The good news about this approach is that it can be applied universally for every property, thereby giving something closer to an apples-to-apples comparison between properties. At Real Estate Ranker, this is fundamentally what we do. We attempt to compare properties in a given area in order to rank them by best value.
There's lots of available information about properties out there, including data we use for our two new metrics: rental estimates, property tax information, hoa fees, and list price. We use the current 30-year fixed mortgage rate in our calculations and assume current market value is the list price. For the purchase, we assume a 20% down payment with another 5% in expenses. For the rental, we estimate expenses to be roughly 25% of rent, which would include a bit extra for possible vacancy. These numbers may differ from reality (especially if you're looking at doing short term rentals) but they allow us to create level comparisons between properties.
Look for cap rate and cash-on-cash return in our ranking lists going forward. Happy property hunting!