Determine Commercial Property Value Using Cap Rates

Determining the value of a commercial property is one of the greatest difficulties that many new commercial real estate investors Real Estate Investor Insurance face. Most people who invest in commercial real estate have experience investing in other niche markets and can use simple math.
The issue that new investors face is the fact that some properties are valued by an approach which determines value based on an average sales price of comparable properties. However, commercial real estate investors determine the fair market value of a property by the income produced by the building divided by the cost of the building. This is called the Cap Rate or Capitalization Rate. Here is an example:
(Net operating income is gross rents minus expenses.)
Net Operating Income: $100,000.00
Purchase Price: $1,000,000.00
CAP rate Professional Photo Real Estate = 10%
The Cap Rate can help you determine the maximum price to pay for a property when you know the net operating income.
Net Operating Income: $150,000.00
CAP Rate: 11%
Maximum purchase price: $1,363.636.00
If an investor is not purchasing the property for cash financing terms will affect the investor’s rate of return on the building. The simple CAP rate is a good number to use when comparing potential investments but more complete analysis is necessary to determine exactly what the true rate of return will be on a particular building when financing is necessary.
The ultimate goal is to determine value. In other words, the investor should only be concerned with paying a price that allows him to realize an acceptable rate of return.
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