When investing in a premises, a house or an apartment, it is important to know the different tools that can indicate which property is more profitable. A method that will help you make a more informed decision is the calculation of the “cap rate” or capitalization rate.
¿What is the cap rate?
The capitalization rate reflects the annual flow percentage that is expected to be generated by a property, in relation to its sale price, without taking into account operational or maintenance expenses (electricity and water services, security, remodeling , etc.) That is, if you plan to acquire a house or apartment to rent it, this information will help you know how much it will generate each year and in approximately how long, you can recover your initial investment.
The cap rate clearly depends on the sale price of the property, however, it is also a measure that is influenced by the area or the characteristics of the land. Taking into account the average cap rate by area, and comparing it with the estimated cap rate for a specific property, can be decisive in evaluating how good a business can be.
For example, in the Escazú area, the capitalization rate is close to 8%. If you calculate that the property you are researching will generate a cap rate of 6%, it may not be the most profitable option. While on the other hand, if the cap rate exceeds the average and reaches 9% or 10%, this indicates that the investment is more attractive, because possibly, you will receive the return of your initial capital in a shorter period of time than the average .
¿How to calculate it?
To do the calculation manually, the following formula is used: R = (i / v) x100 Where the values are interpreted as follows:
- “i” = annual income
- “v” = property value
A specific example is Viva Residences, an apartment in this project sells for $275,000 and can be rented for $2,500 per month. Generating $30,000 a year. Therefore, when applying the formula you would have the following information.
R = (30,000 / 275,000) x100, which would give the result of R = 10.9%. Therefore, the initial investment in the apartment would be expected to be recover in 9.17 years.
There are also digital methods for calculating this flow, which can easily be done using cap rate calculators.
Remember that to assess the financial performance, return of capital, and overall potential of an investment that has captured your interest, it is vital to have a range of tools, not just this one.
Consult with your trusted real estate, finance and legal professionals before making a final decision. Don’t overlook spending time doing a thorough market research to find the property that best meets your needs, expectations and possibilities.
