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What is a CAP rate?

Posted by: raindrop 6 years, 2 months ago

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In commercial property, the value of the property is often computed not by sales comps, but by a "cap rate."  

Cap Rate is an industry term for the capitalization rate of a property.  The capitalization rate of a property is a ratio calculated by taking the net operating income of the property and dividing it by the sale price.  Therefore, the higher the cap rate, the lower the price of the property.

Like any ratio, equation can also be rearranged to establish a value given a particular cap rate.

For example, if you are interested in purchasing a property at a 7% cap rate, all you would need to know is the net operating income of a property.  You would divide the net operating income by the cap rate and you would establish the value.

Market cap rates vary substantially.  In Coronado, cap rates range from 1%-5%.  Lower income areas are seeing cap rates ranging from 7.5% to 11%, which is unusually high and reflects the current economic conditions.

Keep in mind that a cap rate does not establish cash flow, or a cash on cash analysis given that it only is computed using the net operating income, which does not account for any debt service.

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