NOI is the abbreviation for net operating income. Gross income (all money collected with the operation of a business) minus operating expenses (everything EXCEPT debt service, i.e. mortgage payment) equals the net operating income.
The Cap (capitalization) rate is simply the rate of return on a commercial investment if it were purchased with all cash…no financing.
Here’s an example:
If the NOI is $10,000 per year and the seller is advertising this property at a 10 cap rate, the asking price would be $100,000.
NOI divided by Cap rate = Sales price
$10,000/.10 = $100,000
If the property was being sold at an 8 cap rate, the price would be higher:
$10,000/.08 = $125,000
So, the lower the Cap rate, the higher the price.
As investors, we want to buy at the highest possible Cap rate and sell at the lowest possible Cap rate. It’s comparable to buying wholesale and selling retail in the single-family house market.