Income first, then the price
Cap rate and NOI
Cap rate is the price talking. Net operating income is the building talking. Divide the year's NOI by the price and you have the going-in cap rate. It is not cash in your pocket. The loan is not in it.
How NOI is built
NOI is collected income after vacancy and operating expenses, and before loan payments. Depreciation is not in it. Income tax is not in it. A reserve the model treats as an operating line is in it, and you should know that when you compare two deals.
On Cayuga Commons (Illustrative Case) the path is visible. Residential gross potential rent is $691,200.00. Residential vacancy is ($41,472.00). Retail gross potential rent is $159,600.00. Retail vacancy is ($12,768.00). Other income is $45,000.00. Effective gross income is $841,560.00. Operating expenses are ($247,493.60). Year 1 NOI is $594,066.40. Vacancy and operating expenses are reductions, so the engine prints them in parentheses.
- Residential gross potential rent
- $691,200.00
- Residential vacancy
- ($41,472.00)
- Retail gross potential rent
- $159,600.00
- Retail vacancy
- ($12,768.00)
- Other income
- $45,000.00
- Effective gross income
- $841,560.00
- Operating expenses
- ($247,493.60)
- Year 1 NOI
- $594,066.40
Where the expenses go
The operating expenses are not one lump. Taxes, insurance, management, repairs, utilities, marketing, and reserves are each a line. Management and reserves move with income. The others are entered amounts that grow with the expense growth rate, 2.50% a year on this case.
- Real estate taxes
- ($95,000.00)
- Insurance
- ($22,000.00)
- Property management
- ($33,662.40)
- Repairs and maintenance
- ($38,000.00)
- Utilities
- ($28,000.00)
- Marketing and general
- ($14,000.00)
- Reserves
- ($16,831.20)
- Total operating expenses
- ($247,493.60)
From NOI to a cap rate
The price is $8,500,000. Year 1 NOI is $594,066.40. The engine's going-in cap rate is 6.99%. The sale uses the following year's NOI at an exit cap of 6.50%. Those are two different rates, and mixing them is how a memo starts to argue with itself.
The free cap rate calculator divides a NOI you type by a price you type. Use it for one year. Use the model when you also need the loan, the hold, and the sale.
- Purchase price
- $8,500,000
- Year 1 NOI
- $594,066.40
- Going-in cap rate
- 6.99%
- Project IRR
- 15.34%
- Equity multiple
- 2.4351x
- Minimum DSCR
- 1.46x
- Verdict
- PURSUE
Frequently asked questions
Does cap rate include the loan?
No. Cap rate is NOI divided by price, before debt service. Cash flow after the loan is a different measure.
What is NOI?
Net operating income. Collected income after vacancy and operating expenses, before loan payments, depreciation, and income tax.
What are the illustrative figures?
Year 1 NOI is $594,066.40 on a price of $8,500,000. The going-in cap rate is 6.99%. The exit cap used for the sale is 6.50%.
Is a higher cap rate a better deal?
Not by itself. A higher cap rate is a lower price for the same income, or weaker income at the same price. The rest of the model is what says which one you have.