CAP Rate Calculation

[Ryan Pearlman]

Hi Guys! Evaluating a deal at the moment and I am curious how you would calculate your CAP rate. Once our building is stabilized we are anticipating a CAP rate as follows (backed by market data):

1. CAP of 9.57% if we take into account the TOTAL deal cost (purchase price, closing costs, renovations, fees, reserves, etc.) So calculation is our NOI of $158k / total deal cost of 1.65MM

2. CAP of 12.14% if we take into account just the purchase price. So calculation is our NOI of $158k / purchase price of 1.3MM.

Thank you in advance!

Ryan

[Brian Burke]

Cap rate is calculated by taking the TRAILING NOI, typically the trailing 3 months annualized effective gross income minus trailing 12 month expenses, divided by the purchase price. You don't calculate it using income that you EXPECT to achieve, nor do you include ancillary acquisition costs.

Your example 1 is called Yield on Cost, which is a different than cap rate--but is ultimately a better tool to use to evaluate investment performance than cap rate anyway.  Example 2 would be called a proforma cap rate, which is useless unless you are a broker.  Brokers use it to entice buyers who don't understand that cap rate isn't a measurement of investment performance.  

Here are some articles that might help shed some additional light:

https://www.biggerpockets.com/blog/capitalization-rate-defin...

https://www.biggerpockets.com/blog/real-estate-cap-rate-prop...