Executive summary
The capitalisation rate (cap rate) divides a property's net operating income by its value or price. It is a quick way to compare income-producing properties, but it is a snapshot that ignores financing, capital expenditure and growth. Because value equals NOI divided by the cap rate, small changes in cap rates can move values substantially.
Key findings
- 1Value = NOI ÷ cap rate; at $100,000 of NOI, moving from a 6% to a 7% cap rate reduces implied value by about 14%.
- 2A lower cap rate generally implies investors accept a lower current yield in exchange for perceived safety or expected growth.
- 3Cap rates should be compared only across properties with similar risk, location and lease profiles.
Definition
Cap rate = Net operating income ÷ Property value. Net operating income (NOI) is rental and other income, less vacancy and operating expenses, before debt service and income taxes.
Sensitivity: a hypothetical property
For a property producing $100,000 of NOI:
| Cap rate | Implied value |
|---|---|
| 5.0% | $2,000,000 |
| 6.0% | $1,666,667 |
| 7.0% | $1,428,571 |
| 8.0% | $1,250,000 |
| 9.0% | $1,111,111 |
What the cap rate leaves out
- Financing. Two buyers with different leverage see the same cap rate but very different equity returns.
- Capital expenditure. Roofs, systems and tenant improvements are not in NOI but consume cash.
- Growth. A cap rate is a single-year snapshot; rent growth and lease terms drive long-term value.
Use the TIC Cap Rate & NOI Calculator to test your own assumptions.
Exhibit
Implied value of $100,000 NOI by cap rate
Source: TIC calculation
Investment considerations
Compare a property's cap rate with recent comparable transactions and with your own required return, and model capital expenditure separately.
Risks and limitations
Market cap rates change with interest rates and investor sentiment; published averages may lag actual transactions.
Methodology
Arithmetic illustration using value = NOI / cap rate for a hypothetical $100,000 NOI.
Facts, assumptions, estimates and opinions
TIC labels the nature of each material claim so you can weigh it appropriately.
- Verified factValue equals net operating income divided by the capitalisation rate.
- EstimateTable values are calculated for a hypothetical property.
- OpinionCap rate is a useful screening tool but a poor sole basis for an investment decision.
Sources and references
This piece relies on arithmetic and general principles; no external data sources are cited.
Downloads
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