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Great investment property deals in short supply
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Capitalization rate
For long-term investors who plan to hold the property, Crowe uses the capitalization-rate or cap-rate formula. The cap rate is defined as the ratio of yearly net income to the value of the property. It is expressed as follows:

Capitalization-rate formula

Formula: Annual rental income (income - expenses, not including mortgage)/ the purchase price = capitalization rate.

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The cap rate offers a way to compare deals based on the value of the property regardless of the amount of down payment or the interest rate on the loan. While higher mortgage payments would change the return on investment, Crowe says, "It doesn't change the cap rate."

If you're selling a property, says Crowe, "It's better to have a buyer willing to accept a lower cap rate. But if I'm buying, I want a high cap rate." For instance, if you buy a property with a cap rate of 8 percent and did nothing to it but raise the price, the cap rate drops to 7 percent. You've made a profit.

Cap rates vary, depending on the region in which you are investing.

"In the Midwest region a cap rate of 7 percent or 8 percent is considered good," says Crowe.

On the coasts, a cap rate of 6 percent is more common. A decade ago a 10 percent cap rate was customary, says Crowe, who offers real estate investment advice on his Web site www.dougcrowe.com. Crowe has invested in real estate for about 19 years and taught investing in Chicago for about five years.

Bankrate.com's corrections policy -- Posted: May 18, 2006
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