Capitalization Rate

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Capitalization Rate

The capitalization rate (aka: CAP rate) is the income rate of return for a total property that reflects the relationship between one year’s net operating income expectancy and the total price or value. This can be calculated by dividing the net operating income by the sale price or value.

Say the property has an NOI of $125,000, and the price is $1,125,000. Then the cap rate would be 11.1% ($125,000/$1,125,000)

In order to correctly calculate a cap rate, and get an apple to apples comparison, you must know the correct income and expenses for the property. This information is not part of any public record. The only way to access the information would be to contact a principal in the deal, and that just isn’t done because the information is confidential.

The cap rate is a very common and useful ratio in the commercial real estate industry and it can be helpful in several scenarios. For example, it can and often is used to quickly size up an acquisition relative to other potential investment properties. A 5% cap rate acquisition versus a 10% cap rate acquisition for a similar property in a similar location should immediately tell you that one property has a higher risk premium than the other.

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