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What's a Cap Rate? (And Why it Matters!)

What is a Cap Rate?

If you’re a real estate investor, or you’re thinking about investing in real estate for the first time, you’ll want to understand capitalization rates, better known as cap rates. A cap rate is amount of return that can be expected from a real estate investment—in other words, it’s one measure of how profitable your rental property will be. The higher the cap rate, the better your annual return.

It’s especially useful to calculate if you are deciding between two more investment properties that you plan to use for long-term rentals. If you plan to flip your investment property, the cap rate is not so important.

How to calculate a cap rate

First, determine the properties annual operating expenses; these include property management fee (assume 10 percent), Hawaii’s General Excise Tax (GET, 4.712 percent), monthly maintenance fee, property taxes and insurance.

Next, simply divide the property’s price by its net operating income (annual rental income minus annual operating expenses).

For example, a one-bedroom condo in Mililani with a purchase price of $320,000 and a monthly rent of $1,600 with an annual operating cost of $8,160 would have a cap rate of 3.45 percent.

Note: The cap rate calculation assumes an all-cash payment. If you will be financing your investment property, you will need to take into account mortgage costs. You will also need to factor in closing costs and other fees, if applicable.

What is a good cap rate in Hawaii?

A very high cap rate on Oahu is around five percent; however, most cap rates fall between three and four percent. It’s unlikely that an investment property would generate a cap rate above five percent in this market.

Cap rates in Hawaii tend to be lower than the national average because our market has greater appreciation over time. Many Hawaii real estate investors employ a "buy and hold" strategy, counting on the property's long-term appreciation.

Important considerations for Hawaii investment properties

When looking for your Hawaii investment property, you’ll want to keep your operating expenses as low as possible. While purchase price is an important consideration, you’ll also want to shop around for lower maintenance fees and do your homework on possible major expenses, like upcoming assessments on older condominium buildings.

If you plan to purchase an investment property in a zoned hotel district, your tax rate will be higher. As with any major financial decision, you’ll want to consult with a trusted Realtor® and CPA before choosing your Hawaii investment property.

You’ll also want to carefully review condo or homeowners association documents before purchasing an investment property. Vacancies and repairs can hurt your bottom line, and will require you to be more hands-on.

When you factor in Hawaii’s real estate cap rates at around four percent and long-term appreciation of around five percent, plus your monthly dividend in the form of rental income, real estate can be a solid investment.

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