Capitalization Rate (Cap Rate) Calculator
Calculation Results
Net Operating Income (NOI): $0.00
Business Cap Rate: 0.00%
Understanding Capitalization Rate for a Business
The Capitalization Rate, or "Cap Rate," is a fundamental metric used in business valuation and commercial real estate to estimate the potential rate of return on an investment. Unlike ROI, which tracks total return over time including debt, the Cap Rate focuses strictly on the asset's natural ability to generate income relative to its price.
The Cap Rate Formula
To calculate the capitalization rate for a business asset, you use the following formula:
Key Components of the Calculation
- Gross Operating Income: The total revenue generated by the business or asset before any expenses are deducted.
- Operating Expenses: The costs necessary to maintain and operate the asset (e.g., maintenance, insurance, taxes, utilities). Note: Do not include mortgage payments or depreciation.
- Net Operating Income (NOI): This is your Gross Income minus your Operating Expenses. It represents the "cash flow" of the asset itself.
- Market Value: The current price at which the asset could be sold or the original purchase price if you are evaluating an acquisition.
Practical Example
Suppose you are looking at a commercial laundry business listed for $500,000. The business generates $80,000 in annual revenue and has $30,000 in operating costs (rent, utilities, soap, repairs).
- Calculate NOI: $80,000 – $30,000 = $50,000.
- Divide NOI by Value: $50,000 / $500,000 = 0.10.
- Multiply by 100: The Cap Rate is 10%.
Why is Cap Rate Important?
A higher cap rate generally implies a higher potential return, but it also indicates higher risk. Conversely, a lower cap rate suggests a more stable, lower-risk investment (like a prime location storefront). Investors use this tool to compare different business opportunities quickly and determine if the asking price aligns with the market standard for that specific industry.