what is cap

In Buying Property - Asked by Gary F. - Feb 6, 2011

murray a.
Owner/Investor
Cathedral City, CA

Return on Cash Investment.

Feb 6, 2011
Michael D.
Broker/Agent
Hobe Sound, FL

cap is short for "capitalization rate". It is a measure of how long it take an investor to receive his initial capital back. A cap rate of 8 for example means that if an investor places \$100,000 as an equity position he would receive his \$100,000 back in 12.5 years. This would mean that the NOI of that property is \$8,000 per year. The higher the cap rate the better the return to the investor. The lower the cap rate is on a sale the better for the seller of the property. This is a simply definition and the formula to use is: CAP = NOI/current value of asset.

Feb 7, 2011
Rob B.
Chandler, AZ

Gary....I could be trite and answer this question by saying, "a cap is anything that you put on top of something, such as headwear on one's head". But, I don't think you are looking for that. This indeed is Return of Cash Investment. I believe what you are really asking is, "What is a cap rate in commercial real estate and how is it used"? If I am wrong please forgive me for providing an answer to my own formulated question.
A capitalization rate in commercial real estate is a method of determining just how much the purchase price of the property will return on an annual basis, if one pays all cash for the property. (Do not get this confused with "cash on cash" as that is usually the figure that is shown after "net operating income" has been achieved and debt service and other below the line items are deducted).
Cap rate analysis is very helpful in comparing property values one to another. It is also way of comparing a return the value of a property when all cash is paid to the value of a stock when all cash is paid; the value of savings accounts; trust deeds; bonds; and any other alternative method of investing cash.
An example of this is: You consider a purchase of a rental property for \$2 M and pay all cash. Your capitalization rate is 8%. Thus, you have to receive \$160,000 in Net Operating Income (NOI) annually. (Collected rents, minus all operating costs = NOI). Alternatively, you will have the opportunity to purchase a bond for \$2 M that will return a 4% capitalization rate for you. The bond will provide \$80,000 per year of income. It now becomes your choice to determine the risks of the bond and the risks of the real estate purchase. There are many factors to weigh in this decision besides the difference of \$80,000 per year of income between the two investments. This is where investment analysis skill plays a large part. Weighing both risk and reward in the investment of a clientâ€™s funds in commercial real estate is a real necessity in the successful representation of others.
Thus, you I hope you can understand the concept of capitalization rates is a very important step in seeking to become a true commercial real estate professional. Good luck Gary.... Rob Baird, CA RE License #544165 (One of the oldest, active licenses in CA) 951 515-5855 Email: rob@capratecommercial.com

Feb 7, 2011
Steve B.
Owner/Investor
Houston, TX

For a comprehensive discussion of cap rates (too lengthy to post here) see my LoopNet blog, Understanding Cap Rates, at the link below, or simply click on the View Profile link to your left.

Feb 8, 2011
Mark A.
Owner/Investor
Chula Vista, CA

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Simple Terms
A Cap is a ratio used to estimate the value of income producing properties. Put simply, the cap rate is the net operating income divided by the sales price or value of a property expressed as a percentage.
Think: Higher Cap Rate = Higher Return on Your Cash Investment
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Market CAP Rates
A market cap rate is determined by evaluating the financial data of similar properties which have recently sold in a specific market.
The Cap (Or Market Cap) rate may vary in different areas of a city for many reasons such as desirability of location, level of crime and general condition of an area.
You would expect lower cap rates in newer or more desirable areas of a city and higher cap rates in less desirable areas to compensate for the added risk.
In a real estate market where net operating incomes are increasing and cap rates are declining over time for a given type of investment property such as office buildings, values will be generally increasing. If net operating incomes are decreasing and capitalization rates are increasing over time in a given market place, property values will be declining.
If you would like to find out what the cap rate is for a particular type of property in a given market place, check with an appraiser or lender in that area. Be aware that the frequency of sales for commercial income properties in a given market place may be low and reliable capitalization rate data may not be available. If you are able to obtain a market cap rate from an appraiser or lender for the type of property you are evaluating, check to see if the cap rate value was determined with recent sales of comparable properties or if it was constructed.

Feb 10, 2011
Justin W.
Broker/Agent
Orlando, FL

Simple Calc:
NOI/ Present Value or Purchase Price= Cap Rate %
Cap is a short cut for astute Investors/Brokers to quickly understand the Potential Cash Return after some expenses are paid. Each market has its "standard" market cap, it is best to discuss this with seasoned professional.

Feb 10, 2011