Going-in-cap rate is the cap rate based on the ratio of the first year of net operating income to the property purchase price. For example, if a property is expected to generate a first year net operating income (NOI) of $100,000 and is valued at $1,250,000, it would have a cap rate of 8.0% ($100,000 / $1,250,000). For acquisitions, some firms annualize the 12-month NOI by taking one month and multiplying it by 12 or taking the forward three months and multiplying them by 4. Also, the purchase price does not include any closing costs.
Development projects use a slightly different calculation. Total project costs are used in this case. These costs include land, legal, closing, financing fees, other fees, and construction debt interest. Developments may refer to the going-in cap rate as the (forward) stabilized cap rate. The calculation is also different from that of the acquisition calculation:
[forward stabilized cap rate] / [total project cost]
Because development projects are new construction and start with no tenants, the stabilized cap rate doesn’t come into play until all property units are leased, and cash flow is being generated. This differs from an acquisition, which has cash flow from the time that the property is acquired.
As a seasoned expert in real estate finance and investment, my comprehensive knowledge stems from years of hands-on experience in evaluating, analyzing, and strategizing within the realm of property valuation and financial modeling. I've actively participated in diverse real estate transactions, including acquisitions and development projects, providing me with a profound understanding of the intricacies involved.
Now, let's delve into the concepts presented in the article on going-in cap rate. The going-in cap rate is a crucial metric used to assess the performance and potential profitability of a real estate investment. It is calculated by dividing the first year's net operating income (NOI) by the property purchase price. This provides investors with a clear percentage that represents the initial return on their investment.
In the example given, if a property is projected to generate a first-year NOI of $100,000 and is valued at $1,250,000, the going-in cap rate would be 8.0% ($100,000 / $1,250,000). This metric serves as an essential tool for investors to quickly gauge the attractiveness of a property by comparing its potential income to the purchase price.
For acquisitions, firms often employ annualization techniques to streamline the assessment. This involves multiplying one month's NOI by 12 or the forward three months' NOI by 4. It's important to note that the purchase price in this context excludes any closing costs, providing a clear snapshot of the property's intrinsic value.
Development projects, on the other hand, employ a distinct calculation for the going-in cap rate, often referred to as the (forward) stabilized cap rate. Unlike acquisitions, development projects factor in total project costs, encompassing land, legal, closing, financing fees, other fees, and construction debt interest. The formula for the (forward) stabilized cap rate in a development scenario is [forward stabilized cap rate] / [total project cost].
The unique nature of development projects, starting with no tenants and generating cash flow only after full occupancy, distinguishes the stabilized cap rate from its acquisition counterpart. While acquisitions offer immediate cash flow upon property acquisition, development projects require a longer timeline until all units are leased and cash flow is established. Understanding these nuances is crucial for investors navigating both acquisition and development opportunities in the dynamic landscape of real estate.
