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How to Calculate a Capitalization Rate Or Cap Rate

The Capitalization Rate or Cap Rate is a measure of income producing property’s unleveraged interest rate return. The ratio is derived by taking the annual net operating income at the property divided by the property’s value.
Cap Rate = Net Operating Income/Value
EXAMPLE 1 Suppose a property is offered for sale at $3,200,000. The sales broker lists a pro forma NOI of $200,000. The implied cap rate would be the following:
$200,000/$3,200,000 = 0.0625% x 100 = 6.25%
This means that if you purchased the property for $3,200,000 with no debt, and achieved a $200,000 NOI in the first year, you would receive a 6.25% return on your invested equity. The cap rate is a common metric used by brokers, borrowers, lenders and appraisers in real estate. It is easy to understand and a quick metric as to the implied “worth” or “risk” of a property.
One way to understand …