![]() In general, a new commercial building in a dense, urban area will have a lower cap rate (i.e., be more expensive) than the identical building would have in a sparsely populated location. While the price per square foot may be a consideration, cap rates are more frequently used to evaluate commercial properties because most investors are buying them for the cash flow rather than for their own business operations.Ĭap rates enable investors to compare the prices of different buildings in different locations with the same tenant (i.e., a new Walgreens in cities A, B and C), or nearby properties with different tenants (i.e., Walgreens, CVS and Rite Aid). The higher the cap rate, the greater the cash income the property is likely to generate (or, put differently, the less you will pay to acquire the asset in relation to the anticipated initial cash flow). If the transaction closed at this price, the investor could be receiving a 5.45% annual return on the investment. So for example, a property that generates $300,000 in annual net income listed for sale for $5.5 million is being offered at a cap rate of 5.45% (300,000 / 5,500,000). The purchase price used in the formula is the fair market value of the property, excluding any transaction and loan costs. The net operating income (NOI) is the net income generated by the property, usually from tenant rents, less the amount of taxes and any operating expenses, such as insurance and utilities. To find the cap rate, you can use this simple formula:Ĭap Rate = Annual Net Operating Income / Market Value (Price) Prices for commercial properties and residential properties held for investment, however, are more commonly compared using their capitalization rate, or “cap rate.” The cap rate formula is a ratio that relates the rate of return on your investment, based on the income of the property, to the purchase price. ![]() To compare units in the same building, or similar properties in a neighborhood, the price per square foot is a good metric. Major factors impacting prices within a given neighborhood include the square footage of the home, its age, the quality of the construction and finishes and amenities (i.e., number of bathrooms, fireplaces, outdoor space). When purchasing real estate for personal use, such as your home, you select the neighborhood you want to live in, determine your budget, and begin looking at houses in your price range, perhaps with the assistance of a realtor. How to Find the Cap Rate to Evaluate and Compare Properties
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