What is a Good Cap Rate on a Rental Property?

If you're considering a rental property investment in Oklahoma City, familiarity with a related metric known as capitalization rate - cap rate for short - is crucial. This is an important investment metric that allows you to analyze investment returns. But how do you know if a cap rate is a good one, and how do you use it to make investment decisions? Allow First Class Property Solutions to provide some advice! 

What is Cap Rate?

Cap rate is an equation that calculates an approximation of the annual profit you will be able to make based upon your net operating income and at what price you are willing to sell your property for. Anyone interested in Oklahoma property management should pay close attention to how cap rates inform decision-making.

Cap Rate = (Net Operating Income / Property Value) × 100

For instance, if an income property earns NOI of $20,000 a year and is priced at $250,000, an 8% cap rate is calculated. This rate is a useful value that tells us at a glance how well a property is earning its price.

Factors Affecting Cap Rate

There are a number of variables that will affect what your cap rate could be. It is helpful to understand how your rate of return compares when evaluating an opportunity.

Property Type

Various types of property will typically have different cap rates. Single family dwellings will generally have a lower cap rate, ranging from 4-6%, as such property is in high demand and is considered a stable investment. Multifamily property will range from 5-8%, and commercial property will range depending upon its use.

Location

Cap rates also vary greatly depending on a property’s location. In fact, a property that is located in an existing neighborhood in Oklahoma City, with a lot of rental demand and a low vacancy rate, will likely have a lower cap rate because it is priced higher. On the contrary, a property in a new or higher-risk area will have a higher cap rate.

Sell-Side Analyst

Cap rates are affected by economic trends, interest rates, as well as market conditions. An increase in interest rates means that investors will need higher cap rates in order to absorb their increased costs of borrowing. During down economies, cap rates firm up as a result of a decrease in property value, while a robust economy leads to a firming of cap rates.

Property Condition

An investment property that is well maintained and recently upgraded will have a lower cap rate than an investment property that needs a lot of renovation work. Some older buildings that need a lot of renovations will have a higher cap rate. This needs to be adjusted for in terms of renovation costs.

What is Considered a ‘Good’ Cap Rate?

There is no one-size-fits-all solution, although we have a few pointers that might be of use to you. Cap rates in Oklahoma City range widely for rental properties. Many investors will ask, what is a good cap rate on a rental property? The answer will depend on your goals, the neighborhood, and the type of property.

Cap rates of 4-6% generally represent those in favorable areas with steady and predictable income streams. Investments in such assets entail less risk as well as lower returns.

Cap ranges that fall in between (6%-8%) are considered balanced. This is because they often have good returns with moderate risks attached to them. Most seasoned investors find such ranges attractive for building wealth. What’s a good cap rate on rental property? Generally, those middle ranges are often targeted as the sweet spot.

Cap rates of 8-10%+ either indicate emerging markets or investment properties that need more direct property-level oversight. Although higher returns are offered, higher costs of either market or property also exist.

Risk vs. Reward

Cap rate and risk go hand in hand. A 12% cap rate may seem attractive at first glance, but it could indicate problems such as high crime rates, property conditions, or issues with lessees. On the other hand, a 4% cap rate in a desirable neighborhood may promise a smooth income stream with no trouble in sight.

Comparison to Other Investments

In analyzing cap rates, it is important to look at alternative investment returns. Historical stock market returns average 7%-10% per year, though with substantial fluctuations. Bonds could offer returns of 3%-5% with less risk. Cap rates on real estate investments should reflect the extra work involved in property ownership.

Applying Cap Rate to Your Advantage

Cap rate is a useful measure, although it is not a singularly salient one. You should actually use it in conjunction with metrics such as cash return, internal rate of return, as well as market analysis in order to better understand a property. Which cap rate is "good" is a matter of investment criteria and objectives, as well as market. For many, a good cap rate for rental property carefully balances income, risk, and long-term value.



Cap rates in the range of 7-9% represent an attractive balance of yield and risk to most investors. Cap rates that are higher or lower than this range will be attractive to you, depending on your individual situation!