Cap Rate – The Real Estate Investment Yard Stick
Matthew Wisniewski, CCIM
RE/MAX Commercial Group
Commercial Investment Group Lead
One of the first real estate investment terms you may hear when starting in commercial real estate investment is Cap Rate. What is Cap Rate and what does it measure? How can you use Cap to decide if a project meets your investment criteria? We have all these answers for you below
In short, Cap Rate is simply the rate of return on your investment. It is always on the total purchase price, regardless if you have debt on the investment or not. Think of it as the interest rate on a bank account. The higher the Cap Rate, the more interest you are making on the price you paid for the building.
The Cap Rate varies depending on many factors in the market. Some of these can be the strength of the tenant, length of the leases, the quality of the building, comparative rates of returns in other investments and the cost of capital.
As a seller, you are looking to provide a safe and stable property to an investor, so you can sell at a lower Cap Rate. Because you are selling future cash flows, selling at a lower Cap Rate actually makes the selling price higher, as the rate of return becomes lower for the purchaser. This is generally achieved by have high quality tenants with long leases and yearly increases that keep up with or outpace inflation.
Cap Rate is calculated by dividing the Net Operating Income by the purchase price of the building. Cap rate in purchases is normally expressed as the first year of a buyers ownership. For an accurate number, you need to figure in all the expenses as well as future vacancy, capital expenses like roofs and parking lots and any anticipated repairs. Beware of Cap Rates that you have not verified. Often times a “to good to be true” Cap Rap is because a customary expense line is not entered, no vacancy is budgeted or other expenses are left out. A seasoned real estate investment advisor can help make sure that the advertised Cap Rate is the actual rate of return you can expect. They often can also find ways to control expenses and increase revenues to increase your Cap Rate from the current projections.
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About RE/MAX Commercial Group:
Founded in 2009 and based in East Lansing Michigan, RE/MAX Commercial Group has assisted clients from all over the world acquire property for their real estate portfolios. With product specialists in Retail, Office Multi Family and Industrial investments as well as Business Brokerage, they are able to provide expertise in all facets of commercial real estate.
About the Author:
Matthew Wisniewski, CCIM has more than a decade experience in the commercial real estate investment field. In 2013 he earned the prestigious Certified Commercial Investment Member (CCIM) designation, is a past President of the CCIM Michigan Chapter, the current chapter Membership Chair as well as the 2021 Region 7 VP for CCIM Nationally. With hundreds of millions of dollars in transactional experience, his focus is on realistic growth planning and long-term strategies for creating generational wealth. You can reach Matthew here or by phone at 517-321-2800 Ext 118