Cap Rates vs. Property Values Explained

Today, I would like to take some time and outline the definition of a “Cap Rate” as well as how a basic CAP Rate calculation is completed.

The “Cap Rate”, or capitalization rate, is the rate of return on a real estate investment property based on the income that the property is expected to generate. The capitalization rate is used to estimate the investor’s potential return on his or her investment.

Cap Rates can vary from major urban centers to rural areas, however typical cap rates in Central Alberta are around the 7%-8% range depending on location.

Let’s have a look at an example;

Commercial Investment being offered with the following information;

Asking Price: $750,000.00

Net Operating Income (NOI) of the property is $50,000.00

The calculation to identify your cap rate is as follows;

NOI $50,000 divided by the Asset value of $750,000.00

The Cap Rate (or the investor’s potential return) is 6.67%.

The investor in this situation decides they need to achieve a return of 7.5% and prepares an offer on the property to reflect a 7.5% CAP Rate. To figure out how much to offer, we simply reverse the calculation using the NOI of the property as follows: NOI $50,000.00 / 7.5% CAP Rate = $666,667 Asset Value.

In order to achieve a 7.5% Cap Rate, the investor will need to negotiate a purchase price of around $670,000.

 

As always, please trust in the professionals at KLRT Commercial for all of your commercial needs. Any questions please contact us at the numbers below.