A Cap Rate, or Capitilzation Rate, is a measure of anticipated Return On Investment (ROI) that one is considering investing. As a calculation, it is the Net Operating Income (NOI) divided by the price that the property will be purchasedd for. It does not take into account the debt on the property, since the size of the mortgage and it's interest rate and terms will vary for each buyer. By excluding debt coverage from the Cap Rate it provides a consistent comparable ROI - or Cap RAte - for properties. The Cap Rate is also a measure of risk. The higher the Cap Rate the higher the risk and the lower the price an investor will be willing to pay. Conversely, the lower the Cap Rate, the safer the invetment is preceived and therefore, the higher the price an invetor will be willing to pay. The NOI used in the Cap Rate calculation should take into conideration reserves, leasing fees, vacancy factor and replacement fund for items such as new roof, A/C system and parking lot.
May 24, 2010