Cap Rates of Different CRE Properties
For any CRE investor, Capitalization Rate, or Cap Rate for short, is one of the most important terms to know. It is a useful concept for two reasons. First, as a buyer, it helps you better estimate the potential returns on your investment. Second, as a seller, it helps you determine a fair market value for your property.
This article will give a brief overview of how to arrive at a cap rate for a property and what constitutes a good cap rate for different CRE properties.
How to Calculate Cap Rate?
There are many different methods through which you can arrive at a cap rate for a given property. The most widely used approach is to divide the property’s Net Operating Income (NOI) by its current market value and arrive at its percentage.
Formula-wise, Capitalization Rate = (Net Operating Income / Current Market Value) x 100
To illustrate with an example, supposed there is a listed office property for $1 million on downtown Chicago. The yearly gross rental income is $80,000 and operating expenses are $14,000 then: (80000 – 14000)/1,000,000 = 0.066 x 100 = 6.6%
Now, that 6.6% doesn’t itself doesn’t tell us much without us first taking in some context. It is only ‘good’ or ‘bad’ when compared to what are the average cap rates. This leads us to our next section.
Average Cap Rates
Listed below is the average cap rates of different CRE properties across the United States, with the data sourced from the 2019 North America Cap Rate Survey. Ideally, with all other conditions being equal, a CRE with a higher cap rate than the ones listed for its class may constitute a good investment. CRE Class Urban Suburban Industrial 6.27 N/A Multifamily 5.2 5.49 Office 6.67 7.91 Retail 8.46 7.47 Hotel 8.01 8.55 Coming back to our stated example, we can now see that, at 6.6%, it is slightly underperforming the industry’s average. Thus, you will need to assess whether its other merits are enough to overcome its shortcomings and make it a viable investment.
While the Cap Rate is useful, it shouldn’t be the only variable you should take into consideration when assessing the strength of an investment. Various other factors such as expected property appreciation, occupation rate, future cash flows, and account leverage should also be taken into your assessment. If you are a recent investor in the sector, it can be worthwhile to take the assistance of a trusted commercial broker in order to find the best returns for your money.