How does bank determine cap rate with ONLY NOI?

Question

When stabilizing a unit and getting your NOI in a good spot: How does the bank determine the value of the property without a cap rate? If all you have is an NOI, who sets the cap rate, and how?

Matt Moreland · Answer

Ronald said it right. The bank will usually look at market cap rates for similar assets as a rule of thumb but will ultimately value it based on the models their institution uses to minimize risk for themselves and make sure they're hitting the numbers they need based on property income and loan payments.

Ronald Rohde · Answer

its largely made up. They will size the risk and reduce LTV accordingly if they don't agree with market cap rates.

John McKee · Answer

The bank will use an appraiser to decide what the cap rate value is.

Ronald Rohde · Answer

Under the income approach, they are going to discount NOI based on the perceived risk, even if its DSCR its a functional calculation of quailty of income e.g. cap rate.

Ronald Rohde · Answer

Lender wouldn't ask about cap rate, but they absolutely run a quick valuation in their spreads. Its just one data point

Henry Clark · Answer

The words Cap Rate have never come up with our three banks.

They do an appraisal.  Then they do stress test models.       Appraisal will have three components.        A.   Sales comparables

B.   Cost basis.  Unfortunately the database the appraisers use goes back 25 years.  Our cost went up 40% in the last 2 years.  Just coming down. Thus average cost doesn’t help.  Land value. If you bought bare ground they will value near what you paid.  A couple years later they should increase the value since it is in use.

C.  NOI. Your point. They will use this to look at cash flow to pay the note off.  Even though Cap rate doesn’t come up, they are comparing NOI adjusted for cash flow.  To pay the note off.   Which is based on interest rate and your downpayment. Not necessarily the value of the property .

We had two years where we lost money after taxes.  Due to year one depreciation.   They actually like this since your managing Cashflow with less taxes paid.

Trevor Richardson · Answer

Banks care about DSCR and sold $/unit comps. I’ve never had a commercial lender or residential lender ask about cap rates. Cap rates are just too subjective for lending institutions.

Russ Kitzberger · Answer

Cap rate is usually based on market data, there are surveys that look at hundreds of investors and deals of different asset classes.

Novice investment classes have huge swings in cap rates.

The cap rate should be based on the asset, if you are buying a leased asset with a credit tenant, the rate will reflect the (lowered) risk in the tenant/lease. If you are buying something without a lease or with a short term lease, the cap rate will be only based on the property and the overall market risk.

Jon Kelly · Answer

@Ryan C. the immediate market sets the cap rate. The appraisal will show what other multi-family buildings in the area (city / zip code) sold for and their cap rates.

Ask your agent or broker about cap rates in your area.

Ryan Kelly · Answer

@Ryan C. Banks will do an appraisal and value the property in comparison with similar properties in your market. Cap Rate is a metric that mainly the investor will use as an assessment. You may want a 6% Cap Rate and I want a 7% Cap Rate. Our offers will differ accordingly.

How does bank determine cap rate with ONLY NOI?

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