In previous posts, I’ve discussed NOI or Net Operating Income. In case you missed it, your net operating income is the amount of income a property is throwing off after all expenses like taxes, insurance, utilities, and maintenance, but before debt service.
Once you have a handle on the properties NOI, which is a concrete number, you need to find out the purchase or asking price of the property. Remember, there is a direct correlation between the value of a building, and its current NOI.
Once you know the asking price of a property, you can divide your current NOI, by the purchase price, and come up with your capitalization, or cap rate.
Here’s an example:
Current NOI = $500,000
Asking Price = $6,000,000
500,000/6,000,000 = 8.33%
This property is offered at an 8.33 Cap.
What a properties cap rate allows you to do is compare it to other similar assets trading in the marketplace. For instance, if you had two identical office buildings with identical tenants sitting right next to each other, and one was offered at a 10 Cap and the other an 8.3 Cap, you know the 10 Cap is the better buy.
Keep in mind, cap rate is not the holy grail metric when it comes evaluating deals. It is just one component that tells you the current situation of an asset being offered for sale.
Let’s talk about the numbers that really matter next time.