How to Calculate a Cap Rate on Commercial Property – Cost Calculator

Commercial Property Cap Rate Calculator

Net Operating Income (NOI):

Property Value (or Purchase Price):

Results:

Understanding the Capitalization (Cap) Rate

The Capitalization Rate, commonly known as the Cap Rate, is a fundamental metric used in commercial real estate to estimate the potential return on investment for an income-producing property. It is calculated by dividing the property's Net Operating Income (NOI) by its current market value or purchase price.

What is Net Operating Income (NOI)?

Net Operating Income (NOI) represents the annual income generated by a property after deducting all operating expenses, but before accounting for mortgage payments (debt service), depreciation, amortization, and capital expenditures. Key components of NOI include:

Gross Potential Rent: The total rental income if the property were 100% occupied and all tenants paid on time.
Vacancy and Credit Loss: An allowance for periods when units are vacant or tenants default on rent.
Other Income: Revenue from sources like parking fees, laundry facilities, or vending machines.
Operating Expenses: Costs associated with running the property, such as property taxes, insurance, property management fees, utilities (if not paid by tenants), repairs, and maintenance.

The formula for NOI is: NOI = Gross Rental Income + Other Income – Operating Expenses.

How to Calculate the Cap Rate

The Cap Rate formula is straightforward:

Cap Rate = (Net Operating Income / Property Value) * 100

The result is typically expressed as a percentage.

Interpreting the Cap Rate

The Cap Rate provides a snapshot of a property's unleveraged rate of return.

Higher Cap Rate: Generally indicates a higher potential return, but can also signal higher risk or lower property quality.
Lower Cap Rate: Generally suggests a lower potential return, but may also imply a more stable investment, lower risk, or a prime location.

It's crucial to compare the Cap Rate of a property to similar properties in the same market and of the same asset class to make informed investment decisions.

Example Calculation

Let's say a commercial building generates an annual Net Operating Income (NOI) of $75,000. If the current market value or purchase price of the building is $1,000,000, the Cap Rate would be calculated as follows:

Cap Rate = ($75,000 / $1,000,000) * 100 = 0.075 * 100 = 7.5%

This means the property is expected to yield a 7.5% return on investment before considering financing costs.

function calculateCapRate() { var noiInput = document.getElementById("netOperatingIncome"); var valueInput = document.getElementById("propertyValue"); var resultDiv = document.getElementById("result"); var noi = parseFloat(noiInput.value); var propertyValue = parseFloat(valueInput.value); if (isNaN(noi) || isNaN(propertyValue) || propertyValue === 0) { resultDiv.innerHTML = "Please enter valid numbers for Net Operating Income and Property Value. Property Value cannot be zero."; return; } var capRate = (noi / propertyValue) * 100; resultDiv.innerHTML = "The Cap Rate is: " + capRate.toFixed(2) + "%"; }