Commercial Real Estate Cap Rate Calculator
How to Calculate Cap Rate with NOI
The Capitalization Rate, or "Cap Rate," is one of the most critical metrics used in commercial real estate to evaluate the profitability and return potential of an investment property. It represents the yield of a property over a one-year time horizon assuming the property is purchased for cash.
The Cap Rate Formula
To calculate the cap rate, you must first determine the Net Operating Income (NOI). The formula is as follows:
1. Calculate NOI:
NOI = (Gross Rental Income + Other Income) – Operating Expenses
2. Calculate Cap Rate:
Cap Rate = (Net Operating Income / Current Market Value) × 100
Key Definitions
- Gross Rental Income: The total potential rent collected from all units annually.
- Operating Expenses: Costs required to run the property, including property taxes, insurance, utilities, property management fees, and repairs. (Note: This does not include mortgage payments or capital expenditures).
- Current Market Value: The price at which the property would currently sell on the open market, or the purchase price.
Realistic Example:
Imagine an apartment building that generates $100,000 in annual rent. You spend $35,000 a year on taxes, insurance, and repairs. The property is currently valued at $1,000,000.
- NOI = $100,000 – $35,000 = $65,000
- Cap Rate = ($65,000 / $1,000,000) × 100 = 6.5%
Why Cap Rate Matters
Investors use the cap rate to compare similar real estate investments. A higher cap rate generally implies a higher potential return but often comes with higher risk. Conversely, a lower cap rate usually indicates a safer investment in a highly desirable area (like a Tier-1 city). It allows investors to quickly screen properties without getting bogged down by financing structures, as the cap rate focuses purely on the property's performance itself.