Cap Rates: capitalization rate.

Cap rates.

Generally speaking, a Cap Rate (capitalization rate) is a percentage that relates the net annual return made from an investment, to the investments value (assuming you paid cash for the property).

The math formula used to calculate a cap rate is; take the net annual operating income (NOI) and divide by the price of the property.

The investment value of a property is calculated by dividing the NOI by the cap rate. Or put another way; If I want a rate of retrun of X, how much can I pay for a property?

Example: A property earning $50,000 per year (NOI), divided by a 9% cap rate would value that property at $555,555.

Cap rates vary depending on the anticipated, or desired return the investor wants to earn on the invested dollars. Other factors to consider are the risk to the continuation of the properties income, and the condition of the property.

NOI is calculated by taking the properties income, and subtracting the expenses of generating the income. Generally, you consider the past twelve months operating income, less an alowance for vacancy, less operating expenses. Expenses include management fees, advertising, property taxes, insurance etc. Expenses do not include interest, depreciation, improvements or property payments.

Example: For a property where the net operating income (NOI) before mortgage payments and interest is $6,050.00 per year and you wanted a 9% return (Cap Rate) on your investment. The value to you of that property is figured by taking the $6,050 and dividing it by 9% = $67,200. (check your answer $67,200 x 9% = $6,050)

At a 10% cap rate, the properties value is $60,500.

As the rate of return an investor wants goes up, the price an investor will pay for a property goes down. A cap rate, when used as an indicator of value, is only as good as your facts and assumptions regarding the properties income and expenses.

Comparison of Cap Rates

As a rule the older the property, the higher the cap rate should be to compensate for the added risk. Below are some typical national averages of cap rates for different commercial investments.

Retail Strip Centers 9% to 11%

Suburban Office Buildings 9% to 11%

National Warehouses 9% to 9.5%

Self Storage Properties 5% to 12%

Apartments 8% to 9%

Homes 7% to 10%