Net Operating Income ("NOI") ÷ Current Market Value
Cap rates are a core quantitative metric used by real estate investors to assess the attractiveness of a rental property. It is also used by real estate sellers to set an appropriate asking price for rental investment properties. To standardize cap rate calculation for all investors, mortgage related fees including interest expenses are not included in cap rate calculation.
The higher the cap rate, the better. Investors often compare cap rates to the risk free rates of 30 year United States Government Treasury Bonds. Prevailing Cap Rates tend to be lower in competitive markets and for high demand and high conviction asset classes. For example, ecommerce distribution center cap rates should be expected to be lower than cap rates for retail strip mall assets because investors are concerned about the viability of strip malls and bullish on the growth prospects for logistics assets that service ecommerce.
A multi-family rental property with NOI of $100,000 and a current market value of $1,000,000 has a cap rate of 10%. NOI is all revenue including rental income, parking fees, service charges, amenities fees minus all operating expenses. Depending on lease terms and management structure, operating expenses can include property management fees, insurance, maintenance, property taxes and utilities.