What is a Cap Rate

By
Real Estate Appraiser with Lanz Appraisal, LLC 20135667

A Cap Rate, or Capitalization Rate, is a term used in commercial real estate to describe any rate used to convert income to value or price.  This rate is not a rate of return and is actually a ratio. Some weaknesses and strengths of this method are indicated below:

Weaknesses:

 

  • Does not consider impact of financing
  • Does not consider the time value of money
  • Limited utility for making investment decisions
  • Does not consider the impact of taxes (income)
  • Does not account well for uneven cash flows

Strengths:

 

  • Easy to understand
  • Easily extracted from comparable sales and serves as a valuable appraisal tool
  • Minimal work to use

Conclusion:

This rate is often used in the market for pricing and valuing real property for stabilized cash flowing properties given the ease of use. From an appraiser's perspective, some of the weaknesses can be minimized by various techniques of adjustments to the income stream. The two key issues for applicability in this approach are using rates that are specific to the property, and the application of the rate to the cash flows in the same fashion that it was derived from the market.

 

 

 

Comments (4)

Gabe Sanders
Real Estate of Florida specializing in Martin County Residential Homes, Condos and Land Sales - Stuart, FL
Stuart Florida Real Estate

Good explanation Scott.  One of the most used (and sometimes over used) ratios to determine the value of commercial real estate.

Sep 07, 2009 12:18 AM
Michael Setunsky
Woodbridge, VA
Your Commercial Real Estate Link to Northern VA

Scott, welcome to ActiveRain! A necessary tool when valuing properties with an income stream. However, it doesn't preempt a buyers necessity for doing their due diligence. Thanks.

Sep 07, 2009 01:05 AM
Peggy Duffy
The Bailey Team Real Estate - Chantilly, VA

Buyers always want to know CAP rates; it's a sort of apples-to-apples easy comparison for them. Some won't even look at a commercial property if they don't know the CAP rate.

I intereviewed 4 or 5 commercial lenders earlier this year and wrote a blog post on this very subject:

http://peggyduffy.blogspot.com/2009/01/lenders-weigh-in-on-investment-sales.html 

 

 

Sep 07, 2009 01:36 AM
Alix Pinzon
Open Mortgage, LLC NMLS # 2975 - Downey, CA
(562)743-6086

It's nice to see someone writing appraisal related blogs, since we're the brains behind the industry.  I'm going to start following your blogs guys.  Thanks!

Oct 12, 2009 11:07 PM