Investment Property Jargon Explained - CAP Rates

If you are looking to buy some investment property you are sure to meet a barrage of jargon, from R.O.I. to A.P.R., to capitalization rates to net operating income.

Finding your way round the accountant-speak is essential if you are going to plan your property purchase thoroughly.

Doing a little research could make a big difference to the rental income you can achieve or the capital gain you can expect, two important factors for any investment property.

Of course, you could pay a financial adviser, lawyer or notary to do all the work for you, but it's actually not that complicated and this short investment property glossary series should help as a reference guide.

In each part we look at a different piece of investment property jargon. In this, the first in the series, we look at CAP or Capitalization Rates.

CAP or Capitalization Rates

CAP or Capitalization Rates are a way of calculating how fast an investment property will pay for itself. The higher it is, the quicker you make your money back.

The first step is to work out the sales price, if you have bought the property already you can just use the total price you paid for the investment property including closing costs and other fees.

If you haven't bought it yet, use the asking price and add your expected costs.

The next step is to calculate the property's Net Operating Income (N.O.I.). Take the monthly rent that you hope to charge and times it by 12 months, to work out the annual rental income.

Next, work out the monthly operating expenses per month and also multiply them by to find the yearly cost. Then, simply subtract the operating expenses from the rent total to find the Net Operating Income or N.O.I.

When listing expenses be sure to include everything, including maintenance, reserve fund, trusts fees (if applicable), association fees, reserve fund, management, property taxes, insurance, etc.

Finally, all you need to do is take the N.O.I., divide it by the investment property price and multiply by 100 to turn it into a percentage.

Let's take an example: if you think you can rent your property for $3,000 per month, then your annual income would be 12 x $3,000 = $36,000.

Then, if your expenses are $600 per month, that would be $7,200 per year and your N.O.I. would be $36,000 - $7,200 = $28,800.

Divide 28,800 by the purchase price, say $300,000, multiply it by 100 and you find your CAP rate is 9.6%.

This CAP rate is essential for comparing the profitability for your choices of investment property.

Article by Ian F. Campbell at Investment Properties Mexico, experts in Mexico real estate.

Visit their website to find out more about the what Mexico can offer you in terms of investment property.

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Thursday, April 15, 2010