Cap rate or capitalization rate or just cap is the ratio of annual rental income of the property over the purchase price. This number is often shown on commercial property listings. So you must know this jargon if you want to invest in commercial real estate. It’s commonly a number between 3% to 10%.
Makati Office Condominium with 8% Cap Rate!
For those who invest in the stock market, cap rate is the equivalence of the inverse of P/E ratio. So a cap of 5% is equivalent to P/E ratio of 20. The main difference is in real estate the earning is real while it’s accounting earning in the stock market where earning can be reinstated years down the road!
The higher the cap the higher rental income the property produces and thus the less money you need for down payment. Experienced investors often look at the cap to screen out properties with low rental income. Some investors prefer properties with the cap that is higher than the interest rate they pay for the loan. That way they know they collect more from the tenants than they pay the bank.
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