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Cap Rate -
Capitalization Rate |
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The
Capitalization Rate or Cap Rate 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. Investors, lenders
and appraisers use the cap rate to estimate the purchase price for
different types of income producing properties. A market cap rate
is determined by evaluating the financial data of similar properties
which have recently sold in a specific market. It provides a more
reliable estimate of value than a market Gross Rent Multiplier since
the cap rate calculation utilizes more of a property's financial
detail. The GRM calculation only considers a property's selling
price and gross rents. The Cap Rate calculation incorporates a
property's selling price, gross rents, non rental income, vacancy
amount and operating expenses thus providing a more reliable
estimate of value. If we have a seller and
an interested buyer for particular piece of income property, the
seller is trying to get the highest price for the property or sell
at the lowest cap rate possible. The buyer is trying to
purchase the property at the lowest price possible which translates
into a higher cap rate. The lower the selling price the higher
the cap rate. The higher the selling price, the lower the cap rate.
In summary, from an investor's or buyer's perspective, the higher
the cap rate, the better.
Investors expect a larger return when investing in
high risk income properties. The 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 capitalization 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.
When adequate financial data is unavailable, appraisers may
construct a cap rate through analysis of its component parts thus
reducing the credibility of the results. Cap rates which are
determined by evaluating the recent actions of buyers and sellers in
a particular market place will produce the best market value
estimate for a property. |
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If you are able to obtain a market cap rate, you can then use this
information to estimate what similar income properties should sell
for. This will help you to gauge whether or not the asking price
for a particular piece of property is over or under priced. |
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NOI
NOI |
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Cap Rate = ------------------ Estimated Market
Value = --------------
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Market
Value
Cap Rate |
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Example 1: A property has a NOI of $126,000 and the asking
price is $1,200,000. |
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$126,000 |
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Rate = -------------- X 100 = 10.5 |
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$1,200,000 |
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Example 2: A property has a NOI of $120,000 and Cap Rates
in the area for this type of |
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about 10. |
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$120,000 |
| Estimated
Market Value = -------------- = $1,200,000 |
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.10 |
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Net operating income is determined by
subtracting vacancy amount and operating expenses from a property's
gross income. Operating expenses include the following items:
advertising, insurance, maintenance, property taxes, property
management, repairs, supplies, utilities, etc. Operating expenses
do not include the following items; Improvements such as a new roof,
personal property such as a lawn mower, mortgage payments, income
and capital gains taxes, loan origination fees, etc.
Appraisers use the Income Approach, Cost Replacement and Market
Comparison methods to estimate the value of property. The
Income Approach utilizes the theory of Capitalization.
The On Target Real Estate Investment Software
calculates the Cap Rate for an income producing property as you
enter the property data. You can run "what if" scenarios
changing the sales price, rental income, vacancy rate and operating
expense amounts and the cap rate is automatically recalculated.
No need to use a calculator to run different scenarios.
The ratio analysis report summarizes the cap rate data over a ten
year period based on your input data and assumptions.
©
Copyright 2000 - 2012 Advantage Software LLC
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