Press Room: Article
Cap Rate Calculations: How to Determine ROI in an Unsteady Market
Garfield, Eric B. and VanEck, Matthew T. “Cap Rate Calculations: How to Determine ROI in an Unsteady Market.” Commercial Investment Real Estate
Sept/Oct 2009: 36-38.
A capitalization rate is the overall or nonfinanced return on a real estate investment, akin to the return on total assets in accounting terms. A cap rate is calculated as a mathematical relationship between net operating income and an asset’s value. Most commonly cap rates are extracted from transactions of buyers and sellers competing in a marketplace; but they are related to the current state of capital markets as well as the future growth outlook. So how can real estate professionals extract cap rates in today’s market, where few sales exist?
Generally, cap rates are derived from real property sales via the formula cap rate (RO) = NOI ÷ value. In fi rst quarter 2008, this cap rate derivation may have sufficed. However, since then, the conclusions would be misstated
not only because of changes in time, but also because of the subprime lending crisis’ impact and U.S. capital markets’ failure. Thus, real estate professionals not only must be able to interpret market data, but they also must understand the capital markets’ effect on cap rates — especially in illiquid markets, where sales data is limited.