- CAP RATE CALCULATOR BASED ON NOI
- Cap Rate: an Indication of Property Value
- Calculations Example: Office Buildings
- Calculating Cap Rate & NOI as a Guide to Office Building Investment
- Want to Know More? Let CXRE Help!
CAP RATE CALCULATOR BASED ON NOI
Updated for 2019: Whenever an investor is looking to purchase a commercial property, they want to know its potential income. Regardless of whether it’s an office space, commercial retail space, or an apartment complex, having a solid idea about the investment’s return is crucial. Futhermore, this is especially true when comparing similar properties. As a result, we’ve updated this ‘Calculate the Cap Rate’ page for 2019. Moreover, we’d added the above calculator for commercial real estate investors like you to use.
First of all, a common way of calculating this return on an investment is by using the Cap Rate (short for capitalization rate, commonly called the Cap Rate or CAP). Defined by Investopedia as “the rate of return on a real estate investment property based on the income that the property is expected to generate,” the Cap Rate estimates an investor’s annual return on their investment. What’s more, Investopedia provides the following formula for calculating Cap Rate, which is typically used for commercial real estate Cap Rate calculations:
Capitalization Rate = Net Operating Income (NOI) / Current Market Value
Firstly, it is important to know the Net Operating Income (NOI). In effect, NOI indicates the total positive income generated by the investment property. Specifically, NOI is what’s remains once Operating Expenses (variable costs and fixed costs) have been paid from Gross Income. For example, the following formula reflects this:
NOI = Gross Income – Operating Expenses
A Practical Example: Cap Rate NOI Calculator
Once you know the NOI, you can calculate the Cap Rate from that NOI. In order to help you understand, below is a practical example of the Cap Rate formula in action. To explain, if a buyer purchases a building at the Current Market Value of $1M which then creates $100,000 of NOI annually, then the following is true:
$100,000 / $1,000,000 = 0.10 (10%)
In this example, the Cap Rate is 10 percent. In other words, one-tenth of the total cost of the property value is paid by that year’s NOI.
Cap Rate: an Indication of Property Value
For investors, Cap Rate basically represents the percentage of annual return you might expect on a cash purchase. However, this simplified formula doesn’t account for other factors. In general, when comparing two or more investment properties, a lower Cap Rate indicate a higher property value. What’s more, the inverse is also true – higher Cap Rates often translates into lower property values. In order to help you understand this, here are two equations:
Calculations Example: Office Buildings
If the NOI is not published for a certain property, a licensed commercial real estate agent can help you find that information.
In order to make this abstract idea more concrete, consider office buildings. For example, you can calculate office building Cap Rates by using the NOI of other comparable office properties along with the selling prices of recently sold commercial properties. On top of that, when you know a property’s income, you can more accurately determine its value.
Yet at the same time, if the NOI isn’t published for a property, a commercial real estate agent uncover that information for you. Additionally, you can obtain sales data on comparable properties by working with an agent. Moreover, investors like you can get sales data from the tax office where the property is located or from research reports provided by local agents.
When you take the office building’s expenses into account, you can get a fairly solid comparison between similar properties. In the end, this comparison shows discrepancies (either real or perceived) in property costs. As an article from The Balance says, “When two properties seem just alike and one costs more, it could be because it is generating more income or has lower expenses.”
Is There an Ideal Cap Rate?
Twenty years ago, investors could expect a 10% Cap Rate for commercial investments. However, these days that number is more or less a dream. Since 2002, the average Cap Rate for multifamily properties in both major and minor markets have steadily fallen. For example, in 2002, Cap Rates hovered around 8%. Yet by Q3 2018, rates had declined to around 5%.
Reasons to Use Cap Rate
Without a doubt, there are other ways to value potential investments like the price per unit, Gross rent multiplier (GRM), and the 1% rule. However, Cap Rate is frequently a quick, easy way to estimate value with advantages over other methods. Apart from being widely used metric, in general, Cap Rate:
- includes revenue and expenses
- reflects supply and demand for a certain type of asset in a specific at a given time.
- reflects the asset grade
- may be connected to the debt’s interest rate
Reasons Not to Use Cap Rate
As we’ve seen above, Cap Rate is a simple and useful calculation. Specifically, it lets you quickly size up a commercial real estate property. However, in some scenarios, the Cap Rate isn’t as useful.
For example, if the property’s NOI is either irregular or complex (or both), Cap Rate probably isn’t be the best option. In that case, using a discounted cash flow (DCF) analysis would better account for these complexities and irregularities. So although the Cap Rate gives you a quick ‘back-of-the-napkin’ calculation, it may not represent the property as accurately as other calculations.
Calculating Cap Rate & NOI as a Guide to Office Building Investment
In conclusion, determining the value of an office building for investment purposes might seem complicated. However, by calculating the Cap Rate and NOI, you can obtain a fairly accurate value.
Want to Know More? Let CXRE Help!
If you still have questions about Cap Rate and want to know more, contact one of CXRE’s commercial real estate experts today. We’d be happy to help you understand so that you can maximize your investment potential.