Keeper of the "Cap Rate"

In the days before the Internet and phone apps, the Capitalization Rate (“Cap Rate”) was perpetuated by college professors and economists. Today, the formula on how to make the Cap Rate remains the same but the components of measurement somewhat differ. Some subjective elements like property age, location, property type, and income concentration can vary in its application.

What is a Cap Rate?

It’s a metric calculation used in commercial real-estate to estimate current value by evaluating what other investors’ annual return on investment expectations are for similar properties within a market area.  The formula is as follows:

Net operating income (NOI)

      Purchased Price

Why is it utilized?

The Cap Rate is one of several ways to estimate the value of a commercial property and gives an investor a good metric of what sort of returns they will receive from ownership. Also, once you know what other properties Cap Rates are from similar properties that have recently sold in the area, it becomes easy to determine if the value or sales prices are in line with the market. It is also used by lenders in offering mortgage loans to borrowers to help mitigate the risks over leveraging the property with a loan greater than the value. 

Return Adjustments.

The higher the Cap Rate will result in a greater return for the investor.  Properties that garner a higher risk in ownership will typically demand a greater reward for the investor. Conversely,

the lower the rate the lower the risk as well as the return.

Properties Considered?

Properties where income can be verified are typically used to determine the Cap Rates.  Residential properties or vacant land cannot use a Cap Rate methodology, but commercial properties such as apartments, industrial, retail, hospitality, etc. can be used.

Why should I be concerned?

If you work in the mortgage industry or the real-estate industry, it affects you. Your failure to be familiar with this financial tool could be problems for your business model. It’s always a plus to know how to evaluate commercial properties and how an appraisal finds its conclusions.

Now that we can all gain access to the relevant data from the internet and industry apps, we no longer need to rely on potions and vapors from the old “Keepers” of the data. All of us are now, “The Keepers of The Cap Rate”.