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Top Real Estate Markets for Cap Rate

by Ranah AsadAug 17, 2018November 13, 2023

Real estate is continuing to evolve into one of the best ways to make money and financially secure your future. However, finding a profitable investment property in the right location is never a piece of cake. You need to search for the top real estate markets to guarantee you make smart investment decisions.

What distinguishes the top real estate markets from the rest of the crowd? A successful real estate market is one that offers a high return on investment, cash on cash return and cap rate. All these different real estate metrics are crucial for analyzing investment properties. Today, however, we will focus mainly on cap rate and the top real estate markets for cap rate this year!

What is cap rate?

Cap rate is one of many real estate metrics used to estimate the return on investment an investor makes from his/her property, regardless of the financing method used. In order for real estate investors to estimate the cap rate (also known as capitalization rate), they should understand that it is based on the value of the investment property, the property’s expenses as well as the property’s rental income.

Additionally, cap rate helps property investors to identify what percentage of the property’s value they get in profit. This rate which is represented in percentage is important for determining the predicted return on investment before real estate investors waste their money on a property that may or may not be profitable.

The cap rate formula is easy and can be used by any experienced or beginner real estate investor. It looks something like this:

Cap Rate = NOI/Property Price

(NOI = Monthly Rental Income x 12 – Annual Operating Costs)

Smart real estate investors use this formula to calculate the estimated cap rate of investment properties before making the purchase to ensure they find properties with the highest cap rate. Why is it smart to find properties with a high cap rate? Well, the cap rate is related to the level of risk associated with the property. So a property with high cap rate corresponds to a higher level of associated risks. Likewise, a property with a low cap rate corresponds to a low level of associated risks.

I know what you’re thinking, why would property investors look for investment properties with high risks? Well, because higher risks yield higher profitability and visa versus, in theory. Of course, this isn’t a black and white rule to be followed blindly and there are always more factors to consider.

What is a good cap rate?

The question worth asking now is: what is a “good” cap rate? Over the years, this question has become very debatable among property investors. Some investors say that good cap rate should be approximately 10%, while other real estate investors might consider 2% or more cap rate as a good investment. What you need to keep in mind is that cap rates differ from one market to another. You can find low percentage cap rates in some of the top real estate markets. This depends on a number of factors which we will shortly discuss in details.

Nonetheless, cap rate remains an important metric in real estate investing that should be calculated and known before making any investment decisions. All you have to do is study the different top real estate markets and don’t forget to conduct an investment property analysis.

Factors that affect cap rate

Location

You already know how important location is in the real estate investing world. Location affects every aspect of real estate investments including cap rate. For example, an urban location will definitely have a different cap rate from a rural location. Why is that? The demand and associated risks in different real estate markets determine the value of the property and therefore the cap rate and return on investment for your investment property.

Think about it, an area with high demand will have higher priced properties than an area with low demand. Additionally, an area with high demand will have higher associated risks and like I said before, higher associated risks can typically mean higher cap rate.

Investment Type

Different types of investment properties generate different cap rates. Generally, multi-family homes are the ones that generate the lowest cap rates since they are the properties with the lowest associated risks. Multi-family homes have lower risks compared to single family homes since they generate numerous streams of rental income from multiple tenants living in one building. Therefore, your cash flow will have minor alterations, unlike single-family homes which come with higher associated risks.

Real Estate Market

Similar to location, different real estate markets offer different cap rates. One real estate market may consider a certain cap rate good while another may not. Every city, state or neighborhood is related to different values indicating good cap rate. Each real estate market has its own version of costs which include operating costs, rental and more.

Another thing to keep in mind is that cap rate may develop over time in certain real estate markets. In one market, the demand and supply may increase which will change the understanding of what a good cap rate is in that market.

Top Real Estate Markets for Cap Rate

Now that you have a somewhat clear idea of what cap rate is, let’s name the top real estate markets for cap rate for this year. The data below was taken from Mashvisor’s investment property calculator, a real estate investment tool that helps property investors locate the best performing area all over the US.

To start looking for and analyzing the best investment properties in your city and neighborhood of choice, click here.