How to Calculate Cap Rate for Commercial Properties

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Commercial Real Estate Cap Rate Calculator

Annual gross income minus all operating expenses (excluding debt service).

Resulting Capitalization Rate:

function calculateCapRate() { var noi = document.getElementById("netIncome").value; var value = document.getElementById("propertyValue").value; var resultDiv = document.getElementById("capRateResult"); var rateOutput = document.getElementById("rateOutput"); var interpretation = document.getElementById("interpretation"); if (noi === "" || value === "" || parseFloat(value) <= 0) { alert("Please enter valid positive numbers for both fields."); return; } var noiNum = parseFloat(noi); var valueNum = parseFloat(value); var capRate = (noiNum / valueNum) * 100; var formattedRate = capRate.toFixed(2); rateOutput.innerHTML = formattedRate + "%"; resultDiv.style.display = "block"; var interText = "A cap rate of " + formattedRate + "% suggests that for every dollar invested in the asset value, you are generating " + (capRate / 100).toFixed(4) + " cents in annual net operating income."; interpretation.innerHTML = interText; }

How to Calculate Cap Rate for Commercial Properties

In commercial real estate, the Capitalization Rate (or Cap Rate) is the most popular metric used to assess 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.

The Cap Rate Formula

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

Key Components of the Calculation

  • Net Operating Income (NOI): This is the total income generated by the property (rent, parking fees, laundry, etc.) minus all necessary operating expenses. Note: Debt service (mortgage payments) is NOT included in the NOI calculation.
  • Current Market Value: This is the present-day value of the asset or the price at which the property is being purchased.

Practical Example

Imagine you are looking at an office building priced at $2,000,000. After reviewing the financial statements, you see the property generates $250,000 in gross rent. However, it costs $50,000 per year in taxes, insurance, and maintenance.

  1. Calculate NOI: $250,000 – $50,000 = $200,000.
  2. Divide NOI by Value: $200,000 / $2,000,000 = 0.10.
  3. Multiply by 100: 10% Cap Rate.

What is a "Good" Cap Rate?

There is no single "correct" cap rate. Generally, a higher cap rate indicates a higher potential return but also suggests higher risk (e.g., an older building in a struggling neighborhood). A lower cap rate usually indicates a safer investment in a "Class A" location with stable tenants but a slower return on capital.

Limitations to Consider

While useful, the cap rate should not be the only metric you use. It does not account for:

  • Future appreciation or depreciation of the property.
  • Tax benefits or depreciation write-offs.
  • The cost of financing (interest rates).
  • Variable vacancy rates over long periods.

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