A cap rate is a fundamental financial analysis tool for the purchase of income producing assets. Specifically, it is the Gross collected income from an income producing asset, minus all operating expenses charged to that asset, divided by the cost of the asset.
Specifically, in commercial real estate it is all collected income from rents and other sources of property income, minus all the operating expenses of the property. This produces net operating income (NOI). The NOI is then divided by the price paid for the property, which produces the cap rate.
Please note that the interest costs of financing and the annual reduction of a loan created by an amortization schedule are not considered an operating expense. These annual payments are reduced from NOI and create cash flow.
The purpose of a cap rate is to have a comparative between various forms of cash investment, to assist in the determination of the risk and reward for invested capital.
Lastly, cap rates have nothing to do with the percentage you pay a buyer or selling agent. (Of course this "having nothing to do with" statement could be disputed if you pay a high commission to an agent that is capable of selling a very low cap rate property. (The lower the cap rate the higher the cost of the property). Conversely, I would never use an agent that was suggesting I purchase a low cap rate property without having substantial, verifiable,
upside reasons for a purchase that would lead to a value-added increase in the cap rate at the time you intended to sell the property.
I have likely given you information overload on this subject, but as you can see the use of a cap rate in analysis requires a skilled commercial real estate agent that understands the purpose and results of the cap rate factor in the purchase or sale of commercial properties.
Onward and upward Daniel.... Rob Baird, CA RE License #544165 (One of the oldest, active licenses in CA) 951 515-5855 Email: firstname.lastname@example.org
May 16, 2011