A Quick Re-cap (no-pun intended)
As you likely know already, the cap rate is a ratio used to estimate the value of income producing properties. It is the net operating income (NOI) divided by the sales price or value of property, and is expressed as a percentage.
The cap rate is used by appraisers, investors, and lenders to estimate the purchase price for different types of income producing properties.
Example: a property has a NOI of $130,000 and the asking price is $1,300,000.
Cap rate = 130,000/1,300,000 x 100 = 10
How is a Cap Rate Determined?
A cap rate is determined through the evaluation of financial data of like properties sold in a specific market, and provides a more reliable estimate of value than other methods (such as gross rent multiplier) by utilizing more of the financial details of a property.
The cap rate incorporates factors such as a property’s selling price, non rental income, vacancy amount, gross rents, and operating expenses.
Reasons for Cap Rate Variation
The cap rate may vary in different areas of a city or different regions for a myriad of reasons—such as level of crime, desirability of location, and general condition of an area. In general, you’ll see lower capitalization rates in newer, or more upscale and high demand areas of a city, and higher cap rates in less desirable or newly gentrifying areas.
Where Can I Find Information About My Local Cap Rate?
Brokers and assessors in the area would be the best place to start. You can also talk to lenders who will have intimate knowledge of the deals being made where they operate. You can look at other comparable properties in the subject’s market area to understand what is going on. Some kind of local knowledge source will be supremely important.
If you are able to obtain a local cap rate from an appraiser, broker, or lender, check to see if they determined the cap rate value with recent sales of comparable properties, or if they constructed it for the type of property you are evaluating. In some cases, appraisers may construct a cap rate through analysis of its component part—thus reducing the credibility of the results when adequate financial data is unavailable. To produce the best market value estimate for a property, use cap rates which are determined by evaluating the recent actions of buyers and sellers in a particular market place.
You can always contact our helpful team if you have any questions, and be sure to check out our IPV calculator, which includes cap rate as a metric (and may help you visualize this important component of commercial real estate investment). MyNOI also offers a service that can provide you with a local cap rate.
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