What is a Cap Rate? It is likely the most commonly referred to metric in commercial real estate, and used as a measuring stick of risk and return by investors and brokers.
Why is it so important? The cap rate calculates the unlevered yield (or return) of a property over one year, aka the yield before debt is factored in, and also gives investors a general ballpark estimate on where a property will likely sell.
For simplicity and a general rule of thumb, if the capitalization rate, or the "cap" rate, is greater than the interest rate of the debt (if any) for the asset, you’ll generally come out ahead. If the cap rate is lower than the interest rate, you're essentially making a riskier investment.
Further, a lower a cap rate reflects lower risk and results in a higher value. On the other side, a higher cap rate reflects a lower price, higher risk and higher return.
Cap Rate Calculation
Net operating income (NOI) divided by the purchase price of the property
Excel Example
Below is an example of how the cap rate is calculated in excel.
Calculation applied: $100M/$5.0M = 5.0%
Cap Rate Quick Points
The most commonly referred to metric in commercial real estate
Used as a measuring stick of risk and return by investors and brokers
Formula: Net operating income (NOI) divided by the purchase price of the property
The cap rate calculates the unlevered yield (or return) of a property over one year
Cap rates do not factor in debt
Lower a cap rate = lower risk and higher value
Higher cap rate = higher risk and lower value
Want to get content like this straight to your inbox?
Comments