Commercial Cap Rate Calculator Formula
Understand the math behind the commercial cap rate calculator. Each variable explained with a worked example.
Formulas Used
Current Cap Rate
current_cap_rate = cap_rateImplied Value at Target Cap
implied_value = implied_value_at_targetValue Difference
value_difference = implied_value_at_target - property_valuePrice Per $1 of NOI
per_noi_dollar = net_operating_income > 0 ? property_value / net_operating_income : 0NOI Needed for Target Cap at Current Price
noi_increase_for_target = property_value * target_cap_rate / 100Variables
| Variable | Description | Default |
|---|---|---|
net_operating_income | Net Operating Income (NOI)(USD) | 120000 |
property_value | Property Value / Sale Price(USD) | 1500000 |
target_cap_rate | Target Cap Rate for Comparison(%) | 7 |
cap_rate | Derived value= property_value > 0 ? (net_operating_income / property_value) * 100 : 0 | calculated |
implied_value_at_target | Derived value= target_cap_rate > 0 ? net_operating_income / (target_cap_rate / 100) : 0 | calculated |
How It Works
Commercial Cap Rate Analysis
The cap rate is the primary valuation metric for commercial real estate. It represents the unlevered yield an investor receives based on the property's income production.
Formula
Cap Rate = Net Operating Income / Property Value x 100
Implied Value = NOI / Cap Rate
Cap Rate Ranges by Property Type
Cap Rate Compression
When cap rates compress (decrease), property values increase for the same NOI. This happened broadly from 2010-2022 due to low interest rates. Rising interest rates generally cause cap rates to expand.
Worked Example
A commercial property with $120,000 NOI listed at $1,500,000, compared against a 7% target cap rate.
- 01Current cap rate: $120,000 / $1,500,000 = 8.00%
- 02Implied value at 7% cap: $120,000 / 0.07 = $1,714,286
- 03Value difference: $1,714,286 - $1,500,000 = $214,286
- 04Price per $1 of NOI: $1,500,000 / $120,000 = $12.50
- 05NOI needed for 7% cap at current price: $1,500,000 x 7% = $105,000
Frequently Asked Questions
How do commercial cap rates differ from residential?
Commercial cap rates are generally higher (6-9%) than residential (4-7%) because commercial properties carry more risk, including tenant concentration, lease rollover risk, and sensitivity to economic cycles. However, premium commercial assets in gateway markets can have cap rates as low as 4-5%.
Why do cap rates vary by location?
Cap rates reflect perceived risk. Properties in major gateway cities (New York, San Francisco, Los Angeles) trade at lower cap rates because investors perceive them as safer, more liquid investments. Secondary and tertiary markets have higher cap rates to compensate for higher risk.
How do interest rates affect cap rates?
There is a strong correlation between interest rates and cap rates. When interest rates rise, cap rates tend to expand because investors require higher yields, and the increased cost of debt reduces what buyers can pay. The spread between cap rates and treasury rates typically ranges from 150-300 basis points.
Ready to run the numbers?
Open Commercial Cap Rate Calculator