# What is the formal for cap rate?

In Selling Property - Asked by Jim H. - May 16, 2010

Broker/Agent
Columbus, OH

Cap Rate is short for Capitalization Rate which is a common measurement used to compare commercial real estate investments based on their current occupancy and current yield. Cap Rate is calculated by dividing Net Operating Income (NOI) by Purchase Price. Vacant Properties will not have a cap rate. The cap rate is only a general comparison of commercial real estate investments, and once you have short listed a few investment properties, you should do a detailed cash flow analysis to get a better idea of your actual cash flow and capital needs of each property. The cash flow analysis should include the income and expenses associated with the current tenants including costs associated with renewing these leases, the costs and timing of any additional lease up, debt service and net sale proceeds after the remaining mortgage balance is paid off including all sales costs.
President
www.AlterraRE.com

May 16, 2010
MP V.
Researcher
Huntington Beach, CA

Cap rate = NOI divided by total purchase price (ie rate of return per year if you purchased property with 100% cash) So if Cap rate = 5%, this means NOI= \$5000/yr for a \$100,000 property.

May 16, 2010
MP V.
Researcher
Huntington Beach, CA

Cap rate = NOI divided by total purchase price (ie rate of return per year if you purchased property with 100% cash) So if Cap rate = 5%, this means NOI= \$5000/yr for a \$100,000 property.

May 16, 2010
Rob B.
Chandler, AZ

You have been provided he formal answer to cap rate. However, I believe there is a greater understanding that you may be want to know. In selling a property it is not only a fine thing to know the formal definition of cap rate usage, but the practical approach as well.
A cap rate analysis is extremely important. The rate achieved in property ownership is what should "sell" the property. This achievement is accomplished by careful attention to keeping rental income high and expenses low. (The computation of Net Operating Income of course is Adjusted Gross Income minus expenses.
For example a \$1000 change in adjusted gross income will add \$12,000 per year to NOI. If your NOI prior to this adjustment was \$100,000 and your asking price was \$2 million, Viola a 5% cap rate. Change the NOI to \$112,000 and your cap rate with the same sales price becomes 5.6%. Perhaps will be the difference between a non-sale and a sale. Reduce you expenses by \$12,000 per year at the same time and you will get twice as much benefit.

May 17, 2010
Warren D.
Broker/Agent
Washington, DC

Using a cap rate to estimate asset value is ONLY appropriate with a perpetual stream of income. If the income is finite, particularly less than 20 years then value is better estimated by calculating the net present value of the income stream. Example: if a building has a single tenant 4 year lease and the market may not support releasing then its NOT a cap rate valuation but a NPV of the 4 year income stream.

May 18, 2010
Donald D.
Broker/Agent
Palm Beach Gardens, FL

Simple math can be used to find the value to income property by way of using a Capitalization Rate. First find the Net Operating Income (NOI)
Potential Gross Income (PGI) every unit or sq.ft. rented all year long.
minus Vacancy and Collection Loss (V&C)
Equals the Efective Gross Income (EGI)
Minus the Operating Expenses (OE) Fixed, Variable, and Reserves
Equals the Net Operating Income (NOI)
Income (NOI) divided by the Rate (Cap Rate) = Value

May 18, 2010
Jeremy C.
Broker/Agent
Andover, MA

There is no formal or informal cap rate, just the correct cap rate calculation. Check out a free cap rate profits report here.

Jul 10, 2011