In the commercial real estate business, purchasing apartment buildings and rental properties they are often evaluated by their Cap rate (Capitalization Rate). This same principal can be applied to any residential purchase that has a tenant.
The Cap Rate is the rate of return on a real estate investment property based on the income that the property generates and is calculated simply by dividing the property’s annual income by the current market value (or purchase price) the property. For example, a property that is valued at $1,800,000 that generates $5,000/month ($60,000/year) would be:
$60,000 ÷ $1,800,000 = 3.33% Cap Rate
Please keep in mind that Cap Rates should use NET income figures to be accurate. If a detached home generates $60,000/year, you need to account for property taxes and any other expenses that are related to the property (maintenance, repairs, etc). In this example, if the property taxes are $5,000/year and there are $2,500 in other expenses, the net Cap Rate is $52,500 ÷ $1,800,000 = 2.92%
So, which segment of the Vancouver residential real estate market is producing the highest cap rates? Generally speaking, condos are currently leading the pack. There are a few reasons for this:
- Condos are generally more affordable to rent than detached homes so there are more prospective renters looking for condos than detached homes
- Generally speaking, there are more individuals and professional couples (and some young families) looking to rental condos versus single family homes
- There is a ceiling for what many renters are willing to pay
As an example, we currently have a 2 bedroom condo http://patrickweeks.com/property/4-2077-west-3rd-avenue/ listed for $998,000 that rents for $3500/month which translates to a 4.2% Cap Rate. If we look at typical detached homes, here are the numbers:
- East Vancouver Detached valued at $1,800,000 with a monthly rent of $5,000 = 3.33% cap rate
- Westside Detached valued at $3,300,000 with a monthly rent of $6,000 = 2.18% cap rate
Please keep in mind that Cap Rates should use NET income figures to be accurate. If a detached home generates $60,000/year, you need to account for property taxes and any other expenses that are related to the property (maintenance, repairs, strata fees for attached properties, etc).
If you are looking for an investment property or want further clarification about cap rates and how they relate to your real estate goals please get in touch with us today.