OUR THOUGHTS ON:

Cap Rates and Real Estate

Real Estate

By Gennaro DiBello

Recently, a client requested that I clarify the use of the term “cap rate” in the context of the sale of a commercial rental property.

Cap (capitalization) rates are frequently used in the real estate industry. Developers, lenders, investors and appraisers utilize the cap rate ratio to estimate the value of various different types of property.

Generally, a cap rate is a ratio used to determine the value of income producing property. Cap rates can vary based on the current interest rate environment, lease terms of the underlying property and type of tenant occupying the property. The cap rate is applied to the net operating income of the property to determine the value of the property.

As an example of how cap rates can be used to estimate the value of real estate, assume that a property sells at a 10 cap rate. Further assume that the net operating income (NOI) (annual income less direct operating expenses) is $200,000. These assumptions would indicate that the value of the property is $2 million (200,000 divided by 10%). This calculation also suggests that if the buyer paid cash for the property, the buyer would be receiving a 10% return, based upon the evaluation of the risk at the time of purchase and assuming that the NOI would remain consistent into the future. Based on the above example, any upward or downward movement in the cap rate can have a significant impact on the value of the property. Utilizing a cap rate of 8% would indicate a value of $2.5 million (200,000 divided by 8%).

If you would like to discuss the use of cap rates and real estate in further detail, do not hesitate to contact your Schneider Downs representative or any one of our Real Estate Industry Group specialists.

© 2011 Schneider Downs. All rights-reserved. All content on this site is property of Schneider Downs unless otherwise noted and should not be used without written permission.

This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter.

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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.

© 2018 Schneider Downs. All rights-reserved. All content on this site is property of Schneider Downs unless otherwise noted and should not be used without written permission.

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