Reverse Cap Rate Calculator
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What is a Reverse Cap Rate?
A reverse capitalization rate, often referred to as the "yield" or "return," is the percentage return an investor can expect on a real estate property without knowing its purchase price. It essentially tells you what rate of return a property's net operating income (NOI) represents relative to its current market value. This is the inverse calculation of the traditional capitalization rate (Cap Rate).
Understanding the Formula
The formula for calculating the reverse cap rate is straightforward:
Reverse Cap Rate = (Net Operating Income / Property Value) * 100
- Net Operating Income (NOI): This is the annual income generated by a property after deducting all operating expenses, but before accounting for debt service (mortgage payments) and income taxes. Key components of NOI include rental income, minus property taxes, insurance, property management fees, repairs and maintenance, and other operational costs.
- Property Value: This represents the current market value of the real estate property.
Why Use a Reverse Cap Rate?
The reverse cap rate is a valuable tool for several reasons:
- Investment Analysis: It helps investors quickly assess the potential return on a property based on its income-generating capacity and current market valuation, allowing for a quick comparison between different investment opportunities.
- Market Benchmarking: By understanding the reverse cap rate, investors can gauge how a specific property's yield compares to other similar properties in the market.
- Valuation Indication: While not a definitive valuation method, a projected or desired reverse cap rate can inform discussions about a property's potential sale price. If an investor targets a 7% reverse cap rate and the NOI is $70,000, they would infer a property value of $1,000,000 ($70,000 / 0.07).
Example Calculation
Let's consider a commercial property with the following details:
- Net Operating Income (NOI): $75,000 per year
- Current Property Value: $1,250,000
Using the reverse cap rate formula:
Reverse Cap Rate = ($75,000 / $1,250,000) * 100
Reverse Cap Rate = 0.06 * 100
Reverse Cap Rate = 6.0%
This means the property is generating a 6.0% annual return on its current market value before considering any financing costs.