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Capitalization Rate: 0.00%

Understanding the Cap Rate in Commercial Real Estate

The Capitalization Rate, or "Cap Rate," is one of the most critical metrics used by commercial real estate investors to evaluate the profitability and return potential of an income-producing property. It represents the yield of a property over a one-year time horizon assuming the property is purchased with cash.

The Cap Rate Formula

To calculate the cap rate, you must first determine the Net Operating Income (NOI). The NOI is calculated by taking the gross annual rental income and subtracting all operating expenses (excluding mortgage payments, depreciation, and income taxes).

Cap Rate = (Net Operating Income / Current Market Value) × 100

Practical Example

Imagine you are looking at an office building with the following financials:

• Purchase Price: $2,500,000
• Gross Annual Rent: $250,000
• Operating Expenses: $75,000 (Taxes, Utilities, Repairs)

First, calculate the NOI: $250,000 – $75,000 = $175,000.

Next, divide the NOI by the price: $175,000 / $2,500,000 = 0.07. Multiplying by 100 gives you a 7% Cap Rate.

Why Does the Cap Rate Matter?

Investors use cap rates to compare different investment opportunities quickly. A higher cap rate generally implies a higher potential return but often comes with higher risk. Conversely, a lower cap rate typically indicates a safer investment in a highly desirable location (like a "Class A" office building in Manhattan).

Note: Cap rate does not account for financing, future appreciation, or capital expenditures (roof replacements, etc.), so it should be used alongside other metrics like Cash-on-Cash Return and Internal Rate of Return (IRR).

function calculateCapRate() { var price = parseFloat(document.getElementById('property_price').value); var income = parseFloat(document.getElementById('gross_rent').value); var expenses = parseFloat(document.getElementById('operating_expenses').value); var resultArea = document.getElementById('result-area'); var resNoi = document.getElementById('res_noi'); var resCap = document.getElementById('res_cap'); if (isNaN(price) || isNaN(income) || isNaN(expenses) || price <= 0) { alert("Please enter valid positive numbers for all fields."); return; } var noi = income – expenses; var capRate = (noi / price) * 100; // Format as currency resNoi.innerText = new Intl.NumberFormat('en-US', { style: 'currency', currency: 'USD' }).format(noi); // Format as percentage resCap.innerText = capRate.toFixed(2) + "%"; // Show results resultArea.style.display = 'block'; // Smooth scroll to result if on mobile resultArea.scrollIntoView({ behavior: 'smooth', block: 'nearest' }); }