Commercial real estate investors consider a range of factors when evaluating properties. One popular metric is the cap rate. What is the cap rate in commercial real estate? This post will cover commercial real estate cap rates and why investors use them.

Understanding the Cap Rate in Commercial Real Estate

If you are new to real estate investing, you may have heard of cap rates, and you may have even seen properties offering specific cap rates, but you need to know what they are. In simple terms, the cap rate is a way to measure the rate of return on an investment property.

You can calculate the cap rate by dividing net operating income by the market value. The result will be a percentage representing the property’s cap rate. Typical cap rates tend to be between 4% and 10%.

The cap rate gives you a picture of the annual yield of a property. If you see a property for $800,000 listing a 5% cap rate, you should expect NOI of $40,000. It can also indicate stability and risk. Lower cap rates indicate properties with stable income. Properties with higher cap rates might be riskier, but they have more upside.

Now that you understand a cap rate and its purpose let’s cover some of the metrics behind cap rates.

Net Operating Income

Determining the property’s net operating income is critical for an accurate cap rate calculation. You must take gross income and subtract total operating expenses to determine net operating income.

Let’s say you have an office building with twelve units, and each tenant is paying $5,000 monthly rent. That makes your gross income $60,000. If the property has $20,000 in operating expenses, your NOI is $40,000.

Market Value

It is important to note that this is the current market value, not the sale price. In general, investors determine this by using comps. They look for similar properties in the area and adjust for differences. Working with a local real estate professional can help you determine an accurate market value.

Cap Rate Example

Let’s return to the 12-unit office building from the NOI section to create an example of cap rate calculations. We already know the building has a net operating income of $40,000. For this example, let’s say the property has a market value of $500,000.

To determine the cap rate, we divide 40,000 by 500,000. The result is 0.08. That means the property has a cap rate of 8%. Investors can expect to recover their investment in 12.5 years if the rates hold steady. However, cap rates can experience significant variance over time.

Do you need help with commercial real estate in the Columbus, GA, area? Click here to contact the Cummings Commercial Team. We are real estate experts ready to be your guides to the local market. Reach out now to learn more about The Cummings Advantage.

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