Cap rates, or capitalization rates are used extensively as one component in the valuation of apartment investments.  As with most real estate value calculations, cap rates are influenced by national and local market trends, local competition, and supply and demand.  Though it’s just one tool in the apartment valuation toolbox, capitalization rate calculation is used on both the buying and selling side of transactions.

The Cap Rate Calculation

Simply stated, the cap rate of an apartment property is the net operating income divided by the price, either asking or sold price.  It represents the rate at which the investment is recaptured by income.  The higher the cap rate applied to the same income, the lower the price.  The lower the cap rate applied to income, the higher the selling price.  In other words, a high price paid for income has a slower recapture, or lower percentage rate to get the investor’s investment back.  An example:

Net Operating Income / Price  =  Cap Rate

$105,000 / $1,500,000  =  .07, or a Cap Rate of 7%

In this calculation, the price could be either an asking price, or a recently sold price, depending on the buyer or seller’s goals.  If a buyer is considering buying the property in this calculation, the “price” in the calc is the asking price.  The buyer would get the cap rates of comparable properties sold recently in the area to see if this cap rate compares favorably.  If other properties have been selling at 9% cap rates, the price would need to come down to get that cap rate:

$105,000 / .09  =  $1,167,000

As other properties are selling at a 9% cap rate, to be competitive this property would need to be priced at $1,167,000 rather than the higher price it’s listed at with the 7% cap rate.

Looking from a seller’s side, there is a property owned that has a net operating income of $125,000, and the seller would like to determine a probable asking price for the listing.  Going out and getting the comps, prevailing cap rates average 8% for previous sales.  What would a probable listing price be, all other factors being similar to previous comparable sales?

$125,000 / .08  =  $1,562,500

If this seller wants to move the property quickly, using a 9% cap rate would yield a selling price of approximately $1,389,000.  Buyers and lenders will see more value in this apartment property if others are listed at the lower cap rate.

Karen Hanover, CCIM Candidate
Apartment Education Institute, President

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