Commercial Investment Real Estate is the magazine of the CCIM Institute, the leading provider of commercial real estate education. CIRE covers market trends, current developments, and business strategies within the commercial real estate field.
Issue link: http://cire.epubxp.com/i/475894
36 March | April | 2015 Commercial Investment Real Estate Everyone in real estate knows how to calculate a cap rate — or do they? CAP RATE VARIATIONS by Daniel ann Commercial real estate professionals live and breathe capitalization rates. Every trade publication, market participant, and third-party report relating to real estate quotes cap rates for various markets and properties. But ask a group of real estate professionals to calculate a specif c property's cap rate and you are likely to get a variety of answers — despite the simplicity of the formula. If cap rates are widely used and easily calculated, then why does everyone come up with a dif erent answer? T is article looks at the underlying reasons for cap rates varia- tions, ranging from dif erent uses by market participants to dif erent methods of cap rate extraction. While CCIMs are trained to extract cap rates in a certain way, not all market professionals use the same criteria. Understanding how such variables can af ect the cap rate and the value of a property is just as important as developing — and using — a consistent method of cap rate extraction. Cap Rate Overview A cap rate in its simplest form is a return on an investment based on the principle of anticipation. Value is the present worth of future benef ts. A cap rate attempts to quantify the risk prof le of the future benef ts. It is calculated by using a non-complex formula, R=I/V, where I is the net operating income and V is the value of the prop- erty. In more complex terms, a cap rate measures a single-period, unleveraged rate of return on a real estate investment. By converting income into value, a cap rate expresses the relationship of one year's income and value. A cap rate's three main components are net income, property value, and the rate of return. If two of the three variables are known, the unknown variable can be extracted through a simple calculation. Granted, dif erent types of cap rates exist — overall, terminal, equity, mortgage, building, and land — which may cause some con- fusion among market participants. T e overall rate, or OAR, is the cap rate applied to both the land and building and is the most com- monly used rate by real estate professionals. A cap rate is essentially a dividend rate, so one could call the mortgage constant a "lender" cap rate and a cash-on-cash an "equity" cap rate. However, in com- mercial real estate transactions, brokers and investors tend to focus on two cap rates: acquisition and disposition. Leon Belomlinsky