![]() This maximum price should be calculated using the discounted cash flow model. The major question that a real estate investor should answer when considering a particular property investment opportunity is the maximum price that he can pay in order to achieve his/her minimum required rate of return, taking into account the risks associated with specific property and location. In such a case, the investor needs to investigate whether the rents charged to current tenants are considerably below their market level and try to understand as better as possible if there are any special circumstances in terms of income or value increase potential that would justify such a low going-in cap rate. Based on NCREIF (National Council of Real Estate Investment Fiduciaries) data in the US, going-in cap rates for commercial property rarely fall below 6%, especially in the case of office property, so a 3% going-in cap rate would signal a very high price. ![]() For example, an asking price of $10 million for an office property with projected first-year NOI of $300,000, which implies a going-in cap rate of 3% is unreasonably high. Going-in Cap Rate and Seller’s Asking PriceĪn investor considering an acquisition of an income-producing property can calculate the going-in cap rate implied by the seller’s asking price as a quick way of evaluating the reasonableness of the asking price. However, a 95% occupancy is more often used for the calculation of stabilized NOI. This may range from 90% to 95% depending on property type and location. Stabilized NOI refers mainly to the income that the property can produce at a long-term average occupancy in the market within which it competes for tenants. There may be a discrepancy between the two if the property has a high vacancy rate at the time of acquisition. Some authors and analysts when referring to the cap rate calculation refer to the use of a stabilized NOI and some to the use of the NOI of the first year of the holding period (see our post on the cap rate formula for more on this). It is important to distinguish the going-in cap rate that represents the NOI/value relationship at the time of the purchase of a property by an investor from the exit cap rate that represents relationship between NOI and the price at the time of the sale (resale price) of the property by the investor. ![]() ![]() Cap Rate Formula: Read This Before You Use it!Ĭap Rate Compression: How Much Can they Fall?Ĭap Rate and Discount Rate: How do they Differ? ![]()
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