The cap rate (capitalization rate) is the annual net operating income (gross income minus all expenses) of a particular property divided by its cost (or value). For example, if the annual net operating income of a property is $150,000, and its value is $3,000,000, the resulting cap rate will be 5%. So, to determine a cap rate, one needs to know both the annual net operating income and the value of comparable income properties in the surrounding neighborhood or region. The more comparable the buildings in terms of use, size, location, construction type, date of sale, etc., the more reliable the resulting cap rate. On the other hand, a buyer may have his own minimum cap rate in mind. For example, if a buyer will not consider a cap rate of less than 6%, then in his eyes a property with a net operating income of $150,000 has a maximum value of $2,500,000.
Feb 17, 2012