# How is cap rate determined?

#1

Sorry for this question but I am not sure how the cap rate is calculated. I know the net income divided by the cap rate equals the sales price formula but exactly how is the cap rate determined? The park across the street from me sold a year or two ago with a 8.5% cap rate… so is it set by the market? I searched old posts and couldn’t find a definitive answer on this.

#2

cap rate is the rate of return that you will get if you paid all cash for an investment. It is set by the NOI of that property. Market and buyers in the market do set the cap rate…but its not an end all be all investment metric. More than likely your not going to pay cash, so therefore your actual cash on cash return will be higher than this based on having leverage in the deal.

cap rate is calculated by taking the Net operating income(NOI) divided by the purchase price

#3

Thanks. I am aware of that formula and have used it to double check the listing price on properties but the cap rate was listed. I know the park across the street from me sold a couple years ago and the cap rate was 8.5%. I just wondered how they come up with that 8.5%.

#4

The cap rate is set by the purchase price and the NOI of the park…that sets the cap rate of 8.5%

Im confused in what you are asking?

are you asking how did they determine that 8.5% cap rate was fair return when others look for 9-11% is the industry standard per se??

if so…that is up to the investor to decide what they think a property is worth.

#5

The cap rate is as stated, NOI/Purchase Price . In this example, it is 8.5%. You ask how they come up with 8.5%. I think the best way to explain is that it is a multiplier that is established by the market where a typical property trades at that value. Example, if you call a broker and say , hey , what are 400 lot parks trading for in this market of Denver CO? They might tell you that you would expect to buy at a 5 and a half cap.

Hope that helps.

Dont get blinded on buying on actuals, sometimes you can see a way to increase revenue, decrease expenses, that would far out way paying a premium in cap rate, evaluate the whole deal and the whole picture.