Commercial Real Estate Guide
The capitalization rate is net operating income divided by property value. It is a quick way to compare income-producing assets, and a poor way to make a final decision on its own.
Cap rate equals net operating income divided by price. If a property generates $200,000 of NOI and sells for $2,500,000, the cap rate is 8.0%.
Run it the other direction to value an asset: divide NOI by your target cap rate. At a 7% target, that same $200,000 of NOI supports roughly $2,857,000 of value — which is why small NOI changes swing valuations hard.
NOI is effective gross income minus operating expenses. It excludes mortgage payments, capital expenditures, depreciation and the owner's income taxes.
Watch for a seller's pro forma that assumes full occupancy, below-market management fees, or no reserves. Rebuild NOI from actual rent rolls, trailing statements and a realistic vacancy and reserve assumption before you trust any advertised cap rate.
There is no universal number. Cap rates move with interest rates, asset class, tenant credit, lease term, location and building condition — a stabilized net-leased asset will trade tighter than a half-vacant older strip center in the same city.
The useful question is relative: how does this cap rate compare to recent trades of similar property in the same submarket, and does the spread reflect the actual risk you are taking?
It ignores financing entirely, so two buyers with different debt see very different returns on the same cap rate.
It is a single-year snapshot. It says nothing about rent roll rollover, upcoming capital needs, or whether in-place rents are above or below market.
For value-add deals, the going-in cap rate is often meaningless — the stabilized cap rate and the cost to get there are what matter.
Divide the property's annual net operating income by its purchase price or current value. A $200,000 NOI on a $2,500,000 price is an 8% cap rate.
It depends on your goal. A higher cap rate means more income per dollar invested but usually more risk; a lower cap rate typically signals a safer or higher-growth asset.
No. Cap rate is calculated before debt service, which is why two buyers with different loans get different actual returns on the same cap rate.
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