What Is The CAP Rate (Why Should I Pay Attention)?

Commercial real estate owners and buyers always face the same problem. The method to determine the value of commercial real estate; homeowners and buyers rely on market data methods to determine the value by simply recognizing comparable sales in the market. Commercial real estate mostly depends on the income method or income capitalization method to determine the value. The income method needs to know the CAP ratio or capitalization rate.

In order to start the analysis, we must determine the net operating income of the appraisal object. NOI is defined as the net cash flow of real estate, which is determined by deducting operating expenses from total income. Total income includes rent, general expenses, parking income and all other sources of income. Operating expenses refer to all expenses related to real estate operation, including public mistakes, management fees, real estate taxes, utilities, maintenance, etc. The number of Maggie routes is net operating income or net cash flow. This NOI figure is used by us to determine the real estate value.

Investors have many choices when investing. They can deposit their funds in a bank account, and currently their funds can earn 1-2% of the income. They can buy stocks and bonds for higher(but uncertain) returns. Many people choose real estate investment. Assume that investors want to get 5% of the income from their own funds to purchase real estate that generates $50000 NOI annually. The 5% ROI is defined by the CAP ratio. In this case, if the real estate wants to obtain an annual yield of $50000($1000000 multiplied by 5%, $50000), it must be sold at $1000000. The investor requires a 6% return on investment, which should be sold at US $833333(833333 won multiplied by 6%, US $50000). It can be seen from this basic example that the value of real estate will change according to the expected rate of return on investment of investors. When the bank interest rate is high, the real estate price generally falls. Because investors expect to earn more than their bank deposits. When bank interest rates are low, real estate prices generally rise. Because investors hope to obtain lower returns from real estate investment.

Since September 2018, we have seen market interest rates rise. If this situation continues and interest rates continue to rise, we expect that commercial real estate prices will face downward pressure.