Commercial Real Estate Cap Rate Calculator | Commercial Real Estate Loans (2024)
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Cap rate formula: How do you calculate cap rate? The formula for a cap rate is simple: cap rate is the annual NOI divided by the market value of the property. For example, a property worth $10 million generating $500,000 of NOI would have a cap rate of 5%.
Calculated by dividing a property's net operating income by its asset value, the cap rate is an assessment of the yield of a property over one year. For example, a property worth $14 million generating $600,000 of NOI would have a cap rate of 4.3%.
A 7.5% cap rate means the investment property will generate a net operating income which equates to 7.5% of the property's value. For example: A $300,000 property with a 7.5% cap rate would generate a net operating income of $22,500.
If you invested $1,000,000 in a property, with a 6% CAP rate, you would receive $60,000, at year-end. Or if your commercial real estate property is generating $100,000 of net operating income per year and the market's CAP rate is 10%. The value of the property is $1,000,000 (100,000 (property value)/. 10 (CAP rate).
Average cap rates range from 4% to 10%. Generally, the higher the cap rate, the higher the risk. A cap rate above 7% may be perceived as a riskier investment, whereas a cap rate below 5% may be seen as a safer bet. If a property has a 10% cap rate, you should expect to recover your investment in about 10 years.
The cap rate formula divides the net operating income (NOI) that a property generates before debt service (P&I) by the property value or asking price: Cap Rate = NOI / Property Value.
Generally, a cap rate of 8-10% is considered a good cap rate for a rental property, however, cap rates can vary significantly depending on the market and the type of property. For example, a cap rate of 6-7% may be considered good for a multifamily property in a high-demand market.
Cap rates are seen as a measure of risk and return, a “low” cap rate of 3-5% would mean the asset is lower risk and higher value; a “higher” cap rate of 8-10% reflects a lower price, higher risk and higher return.⁶
Market analysts say an ideal cap rate is between five and 10 percent; the exact number will depend on the property type and location. In comparison, a cap rate lower than five percent denotes lesser risk but a more extended period to recover an investment.
This is a general rule of thumb that determines a base level of rental income a rental property should generate. Following the 2% rule, an investor can expect to realize a gross yield from a rental property if the monthly rent is at least 2% of the purchase price.
Cap rate and ROI are not the same. The cap rate is the expected return based on the property value, but the ROI is the return on your cash investment, not the market value.
If the cap rate (capitalization rate) of a property is lower than the interest rate on a loan used to purchase it, it generally indicates that the property's income, after accounting for operating expenses, is not sufficient to cover the cost of the debt.
For real estate investments, Cap Rates are calculated by dividing your Net Operating Income (NOI), or Rent minus Expenses, by the market value of a property. Your expenses include everything except mortgage payments.
In general, people tend to agree that a “good” cap rate can be anywhere from 5-10%, but even this should depend on your risk tolerance, the specific asset class, and your ideal time horizon for the investment. So while cap rates can be useful, they should never be the only metric you should consider.
Let's take a look at an example. Ivan the Investor acquired a property for $1 million. During the twelve months before the acquisition, the property produced Net Operating Income (NOI) of $65,000. This means the historical cap rate is 6.5% ($65,000 / $1,000,000).
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