The MrRental Blog

Cap Rate

by Jes Herman May 17th, 2010

The capitalization rate, or “cap rate,” is the ratio of net operating income (NOI) to purchase price. To calculate the cap rate, simply divide the NOI (income after all expenses, but does not include any debt service) by the purchase price.

Cap rate = Net Operating Income / Purchase Price

For example, a building with a NOI of $50,000 and a purchase price of $500,000 would have a cap rate of 10.

Cap rate = $50,000 / $500,000 = 0.10 = 10%

You can also work this calculation in reverse. If you are selling a property and your NOI is $65,000, for example, and the going cap rate for your market is 9, what is your property’s value?

Value = NOI / Cap rate
Value = $50,000 / 0.09 = $555,555

Historically, the average cap rate has been ten. If you are a seller, you’d like to get your cap rate below that. If you are a buyer, you want to get above that. Keep in mind, however, that while this valuation method is the measurement for commercial properties, it is rarely, if ever, used for valuing residential properties.

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