Homebuyer Advice: Capitalization Rates

Homebuyer Advice: Capitalization Rates

Homebuyer Advice: Capitalization Rates

Second properties can be purchased to gain secondary income. They consider it an investment or an income property. You can opt to rent it out in order to help pay the mortgage. The main objective for many is receiving an equal or higher return on the purchase price once it is resold. Many homeowners need an additional income source, which is helpful in a myriad of situations.

Every so often simply knowing the difference between your mortgage payments and what you are making each month isn't sufficient enough, though. When the investment will actually begin to pay off certainly isn't explained. How can you determine an investment's return, then? Enter: a capitalization rate calculation.

A capitalization rate, also known as a cap rate, is the ratio between the total operating revenue generated by an asset of some sort and its capital cost. That makes total sense, right? Within that complex finance jargon, probably not. Simply put, the ratio between what it costs to keep your asset running and the original price you paid for it is what a capitalization rate is. This could be the monthly cost of the mortgage on your investment property (subtracted by any additional costs you're able to earn back if you rent it out), divided by what you initially paid for it to begin with, to use an actual example. Once calculated, your capitalization rate will equal a percentage figure.

Keep in mind that, as an investor, you also have to account for the "opportunity cost" of keeping your own money caught up in this particular investment. There's a possibility you could lose out on investments elsewhere because of retaining and maintaining this one property. Before you choose to invest, this would be something that is ideal to mull over.

The capitalization rate is thus a useful tool in calculating the potential investment income you can earn over a period of time. By adding in the initial property cost, it is customizable and also based on real-world fiscal figures. For greater accuracy, renter income can also be added into the calculation. When it's possible you to make more money investing elsewhere, just be certain to do your homework before investing it in a property.

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