How to Calculate Cap Rate:

Here’s your Commercial Real Estate 101: 

Value of income producing property is never about sales comparables of like properties like residential.  It’s only based on the income approach to value.  Look at the attached example. 

Potential/Gross income is the properties maximum income at 100% full occupancy.

Minus Vacancy Haircut which is underwritten as the actual or market whichever is higher.

Equals Effective Gross income – Potential Max Income minus haircut

 

Minus All Operating Expenses

 

NOI- Net Operating History is the most important number is commercial lending b/c you can derive any value of a property with NOI and Cap Rate.

Cap Rate- is defined

A capitalization rate (or "cap rate") is a measure of the ratio between the cash flow produced by an asset (usually real estate) and its capital cost (the original price paid to own the asset) or alternatively its current market value. The rate is calculated in a simple fashion as follows:

·         annual cash flow / cost (or value) = Capitalization Rate

For example, if a building is purchased for $1,000,000 sale price and it produces $100,000 in positive net cash flow (the amount left over after fixed costs and variable costs are subtracted from gross lease income) during one year, then:

·         $100,000 / $1,000,000 = 0.10 = 10%

The asset's capitalization rate is ten percent.

Note that in real estate appraisal in the U.S., a stylized measure of cash flow is used, called net operating income. It is essentially the same as net cash flow, except that debt service and income taxes are not included while a reserve for replacements is included.

Remember:  the lower the cap, the higher the value for the same NOI

The higher the cap, the lower the value for the same NOI.

 

That’s it.  This works for all income producing properties.  Easiest on Multi-Family but works for everything.

 

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