Real estate can be a lucrative business, but you need to be sure that a particular investment will be profitable in the long run. Many investors use what is called a cap rate to determine the profitability of a potential investment. Here is a closer look at this concept and which cities currently have the highest cap rate.
What is Cap Rate?
Cap rate is a figure used to express the rate of return on a commercial real estate property. It’s calculated by taking the net operating income and dividing it by the property’s value. It is expressed as a percentage and can be used to estimate a general rate of return for an investment.
Say a rental building is worth $500,000 and expected to bring in $50,000 per year in rental income. But it costs around $15,000 to maintain and own the property. This would mean the property has a net operating income of $35,000 (50,000 – 15,000).
To calculate the cap rate, you take 35000 / 500,000 which equals 0.7 or 7%. This means that the investment will yield a return of 7% each year if you’ve done the math correctly. To get a better sense of the cap rate of a rental property that you are analyzing, be sure to use our Cap Rate Calculator.
What is a Good Cap Rate 2021?
Determining a good cap rate all depends on how much money you have to spend and how much risk you’re willing to take on. It also depends on your local market and the type of building you’re looking to invest in. A solid cap rate is usually somewhere around 4-5% but can go all the way up to 20%. Multifamily rental buildings tend to have lower cap rates than office complexes or other commercial properties. But it depends on the market and the features of the property.
Keep in mind that the higher the cap rate, the more potential profit. But, like any other investment, the higher the return, the more risk associated. To find a cap rate you’re comfortable with you’ll have to decide how much risk you’re willing to take on. A property with a 12% cap rate might look more appealing than one with a rate of 4%. But, the latter might actually be more profitable in the long run if there is a change in the market or some other factor that impacts the investment. So, you have to crunch the numbers carefully to find out what makes sense for your situation.
1. Baltimore, MD
With an average cap rate of just over 7% for office buildings and between 4.25 – 4.75% for multifamily properties, Baltimore is one of the best cities for purchasing real estate. This is due to low property values and cost of maintenance, coupled with a high demand for rentals.
2. Detroit, MI
Detroit is another popular city for purchasing rental properties that features a cap rate of 4.1% for traditional rental buildings. It’s the largest city in Michigan and presents a variety of interesting opportunities for investors. Detroit offers low property values and is undergoing a revitalization process that will likely increase demand substantially in the coming years.
3. Jackson, MS
Although often ignored by major investors, Jackson, Mississippi has a strong rental market with a cap rate of around 4.5% for multifamily buildings and up to 8% for commercial properties. Jackson is the capital of Mississippi and features consistent population growth and a healthy local economy, but the cost of living is much more affordable than other places in the US.
4. Baton Rouge, LA
Baton Rouge is another great city of real estate investment and features a cap rate of over 8% for large commercial properties and around 4% for traditional multi-family properties. Baton Rouge offers affordable living and low taxes that are attractive to both renters and businesses, which creates consistent demand for investors.
5. Cleveland, OH
Cleveland, OH is a good city to check out if you’re looking to invest in the Midwest. With a cap rate at around 7.7 % for office buildings and around 4-5% for rental buildings, it offers a low cost of entry but a high potential for returns.
6. Pittsburg, PA
Pittsburg is another often overlooked city that offers a robust market for real estate investors. With cap rates for multifamily buildings as high as 6% and a strong market for renters, Pittsburg offers interesting real estate opportunities.
7. Memphis, TN
Memphis, TN offers a stable real estate market that is expected to continue to grow throughout the next decade. It was ranked one of the cheapest places to live in the US and reported one of the highest multifamily rent growths in the country in 2020, giving it a high cap rate that is attractive to investors.
8. Augusta, GA
Although Atlanta often gets all the attention from investors, Augusta, GA offers plenty of attractive deals to real estate investors. The median cap rate for all commercial properties in Augusta is around 7.6%, which is .3% higher than the Atlanta area. Augusta is a fast-growing city with a hot rental market and was rated one of the best places to live in the US by US News and World Report. Combined with affordable living, Augusta features a strong market for real estate.
9. Tampa, Fl
Tampa is another well-kept secret for real estate investors. While other cities like Miami and Orlando often get the most attention, Tampa offers an affordable real estate market with high demand for rentals and close proximity to beaches and other attractions that make Florida so popular. The cap rate for multifamily buildings is somewhere in the ballpark of 4.5-6%, while larger commercial properties like hotels can expect a yield of 6-8%.
10. Indianapolis, IN
Indianapolis offers one of the most affordable housing markets in the country, as well as a variety of profitable opportunities for real estate investors. With a prime location, strong local economy, and high quality of life, it has become one of the most sought-after cities in the Midwest. With a median cap rate for all commercial properties around 7.2%, there is no shortage of profitable real estate deals to be found in the city of Indianapolis.