When analyzing an income-producing property, the first thing most investors want to know is the cap rate. If the cap rate is off, the investor may not even view the property. Yet many novice investors and even seasoned real estate professionals do not properly understand cap rates. When you understand capitalization rates, you will gain a strategic advantage in negotiating the purchase or sale of income-producing property.

If you’re a seller, you want to sell the property for a very low cap rate. An investor on the other hand, wants to buy for the highest cap rate possible.

So what is the cap rate?

The cap rate is simply the property’s net operating income divided by the sales price. This is important because it tells you how long it will take the income generated by the asset to pay for that asset. Ultimately, an investment should not cost you, the investor, anything. It should pay for itself and give you a return.

What return on investment should you look for?

You should compare the return on investment, or ROI, of the potential property with the ROI available to you from other investments. Select the investment that provides you the highest return but which carries an amount of risk that you are comfortable with. Every investment is a balance between risk and reward.

Although there are strategies which make it possible to attain an infinite return on your investment, ROI is largely a function of how you finance the property and is beyond the scope of this article. For our purposes here, suffice it to say that as a buyer you want to purchase an investment at the highest cap rate possible.

Where to find investment deals with high cap rates 

Sellers are incentivized to sell at the highest possible price, which unfortunately means the lowest cap rate for you, the investor. But there are a myriad of reasons a seller may choose to sell their asset at a great cap rate to you and move on to other ventures. Just as in single-family residential investing, the deals in multifamily real estate investing are where the motivated sellers are. The only way to find the deals is by talking with property owners or getting yourself a competent real estate agent who will reach out to property owners on your behalf.