Using the capitalization rate, or cap rate, is a common tool in commercial real estate investing, though it is often misunderstood. The cap rate is the ratio of Net Operating Income (NOI) to property asset value. What this represents is the projected return an investor can expect, assuming an all cash purchase. For example, if a property generates a NOI of $100,000 and it was listed for $1,000,000, then the cap rate would be $100,000/$1,000,000 or 10%.

Investors use the cap rate to calculate the risk of an investment property versus other properties. The higher the cap rate, the lower the valuation multiple, or estimation of worth. Brokers also use the cap rate to evaluate market trends. By looking at historical cap rate trends in a certain market, you can often estimate where the market is headed and have some insight into the direction of valuations.

While the cap rate can tell you a lot about a property, it can also leave out some important factors such as irregular cash flows. To accurately calculate the cap rate, you need to know the correct income and expenses for a property, which can only be found by contacting a principal in the deal, since this information is not public.

Calculating the valuation of an investment, its risk, determining market trends, and more is often an intricate and detailed process that requires knowledge from an experienced broker. If you’re looking for a team that has the comprehensive knowledge it takes to make a sound investment and has the experience to go along with it, look no further than Harkins Commercial.