Commercial Real Estate Cap Rate Calculator
Results Summary
How to Calculate Cap Rate on Commercial Real Estate
The Capitalization Rate (Cap Rate) is the most fundamental metric used in commercial real estate to evaluate the potential return on an investment property. It represents the yield of a property over a one-year time horizon assuming the asset was purchased with cash and no financing.
The Cap Rate Formula
Step-by-Step Calculation
- Determine Gross Potential Income: Sum all expected rental income and additional revenue (parking, laundry, storage).
- Account for Vacancy: Subtract the expected vacancy losses from the gross income to get the Effective Gross Income (EGI).
- Calculate Operating Expenses: Total all costs required to run the property (taxes, insurance, maintenance, utilities, management fees). Note: Do not include mortgage interest or depreciation.
- Find Net Operating Income (NOI): Subtract operating expenses from the EGI.
- Divide by Price: Divide the NOI by the purchase price or current market value of the property.
Real-World Example
Suppose you are looking at a retail strip mall priced at $2,000,000. The property generates $180,000 in annual rent and has a 5% vacancy rate. Annual expenses (taxes, repairs, etc.) total $50,000.
- EGI = $180,000 – ($180,000 * 0.05) = $171,000
- NOI = $171,000 – $50,000 = $121,000
- Cap Rate = ($121,000 / $2,000,000) = 0.0605 or 6.05%
What is a "Good" Cap Rate?
Cap rates typically reflect risk. A lower cap rate (4-5%) usually indicates a lower-risk property in a "prime" location with high demand. A higher cap rate (8-10%+) often suggests a higher-risk investment, perhaps in a secondary market or an older building requiring significant maintenance. Understanding the market average for your specific asset class (Office, Industrial, Retail, Multi-family) is crucial for accurate valuation.