Commercial Real Estate Cap Rate Calculator
Understanding Cap Rate in Commercial Real Estate
The Capitalization Rate, or "Cap Rate," is a fundamental metric used by commercial real estate investors 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 with cash.
In simple terms, the Cap Rate indicates the expected rate of return that will be generated on a real estate investment property. This tool helps investors compare different investment opportunities quickly and efficiently.
The Cap Rate Formula
To calculate the Cap Rate, you must first determine the Net Operating Income (NOI) of the property. The formula is expressed as:
Cap Rate = (Net Operating Income / Current Market Value) × 100
Key Components of the Calculation
- Gross Potential Income: The total income the property would generate if 100% leased.
- Vacancy Loss: The amount of rental income lost due to unoccupied units or tenants failing to pay.
- Operating Expenses: Costs required to operate the property, including taxes, insurance, utilities, and management fees. (Note: This does not include mortgage interest or depreciation).
- Net Operating Income (NOI): Gross income minus operating expenses.
Example Calculation
Imagine you are looking at a retail strip mall with the following profile:
| Item | Value |
|---|---|
| Purchase Price | $2,500,000 |
| Annual Rental Income | $250,000 |
| Operating Expenses | $75,000 |
| Net Operating Income (NOI) | $175,000 |
| Resulting Cap Rate | 7.0% |
In this scenario, a 7% cap rate means the property yields a 7% annual return on its purchase price before any financing costs or taxes are considered.
What is a "Good" Cap Rate?
A "good" cap rate is subjective and depends heavily on the asset class and location. Lower cap rates (4% – 5%) are typically found in "Core" markets like New York or San Francisco where risk is perceived as lower. Higher cap rates (8% – 10%+) are often found in "Value-Add" opportunities or secondary markets where there might be higher risk but greater potential for cash flow.