It’s important to clarify this, because the trailing cap rate could be very different than the initial cap rate. For example, if there’s a forecasted change to property revenues (such as an increase or decrease in occupancy or increasing rental rates due to renovations) or expenses (such as an increase or decrease in property taxes or changes to operating expenses), the cap rate won’t be an accurate gauge to determine value.Ĭap rates are heavily influenced by the expected future growth of the underlying NOI, credit of the tenant, contractual length of the leases, and the liquidity available in that investment market. Assets located in primary coastal markets in the United States and other global centers like London, Tokyo and Sydney all have global investors clamoring to purchase the limited amount of assets that exist in those markets. As a result, they are all considered extremely liquid investment markets and the amount of investor demand places upward pressure on prices, resulting in lower cap rates. These markets also tend to have strong economic growth factors that make it possible for owners to increase their rents, relative to markets with weaker fundamentals. For example, with substantial market rent growth increases a property in New York with a 4% cap rate could increase yield to 6%-8% and appreciate significantly in value. In other cases, the cap rate is an “initial” or “going-in” cap rate, which reflects the forecasted NOI for the first 12 months of ownership. For example, if a property generates $500,000 of NOI in the first year of ownership and it sold for $8 million, the initial cap rate is 6.25% ($500,000 divided by $8,000,000).Ī cap rate represents a snapshot in time. In some cases, the cap rate is a “trailing cap rate,” which represents the NOI generated at the property for the preceding 12-month period. The cap rate is calculated by taking the Net Operating Income (NOI), which is the property revenue, minus the necessary operating expenses, and dividing it by the purchase price. Think of a cap rate as the dividend one would receive in the first year if the property were acquired with all cash.
The question is simple but the answer is complicated because valuing real estate never comes down to a single metric. We’ve acquired properties with cap rates below zero and passed on others with cap rates above 15%.Ī cap rate is the rate of return you’d expect to receive from a property during the first year of ownership, excluding the cost to improve the property and financing costs.
Many investors ask us what capitalization rate (cap rate) we used to acquire a property.
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