Discount Rates vs. Cap Rates in CRE Analysis!

[Bill Rapp]

Discount rates and capitalization rates (cap rates) are two fundamental concepts in commercial real estate (CRE) analysis. They both play a crucial role in determining a property's value, but understanding the nuances between them is essential for making informed investment decisions.

Think of a cap rate as a shortcut for property valuation. It expresses the relationship between a property's annual net operating income (NOI) and its current market value. It's calculated by dividing the NOI by the property value.

While cap rates provide a quick valuation metric, they don't account for future income streams. This is where discount rates come in. A discount rate reflects the minimum rate of return an investor expects to receive on their investment, considering the inherent risks associated with the property. Discount rates are used to consider a series of future NOIs, not just the current one.

The critical distinction between cap rates and discount rates lies in their time horizon. Cap rates offer a valuation based on a single year's NOI, while discount rates consider the property's entire income-generating potential over a specified period.