1
The Use and Selection of Cap Rates
2
Basic Cap Rate Valuation
Cap Rate = Stabilized NOI/Value = 1/Multiple
Multiple = Value/Stabilized NOI = 1/Cap Rate
Value = Multiple*Stabilized NOI = Stabilized NOI/Cap Rate
Note an "8 cap" = .08 = 8% = 12.5 Multiple
Cap Rate Calculation
Cap Rate = Stabilized NOI (yr 1)/Value
Value = Stabilized NOI (yr 1)/ Cap Rate
Cap Rate Calculation
Information
Yield on 10 Year T Note
3.60%
Risk Premium
100 basis points (bp)
Cap Rate
3.6%+100bp = 4.6
Multiple
1/.046 = 21.7x
NOI
$3MM
Valuation
With Cap Rate
3/.046 = $65.2MM
With Multiple
3 * 21.7 = $65.2MM
Summary
3
Gordon Growth Model:
Simple Cap Rate Estimation
Value = (NOI) / (discount rate – growth rate) = NOI/Cap
Therefore: CAP = (r - g)
*Unless stated otherwise assume Stabilized NOI
Growth and Discounting*
Information
Discount Rate
4.6%
Growth Rate
1.0%
Gordon Calculation
1/(.046-.01) = 27.8
Multiple
27.8x
Cap Rate
.046-.01 = .036 = 3.6%
Summary
Information
Discount Rate
5.6%
Growth Rate
1.0%
Multiple with growth
[1/(r-g)]=1/(.056-.01)=21.7x
Multiple with no growth
[1/r]=1/.056=17.9x
NOI this year
$3 MM
Valuation
NOI next year
$3 MM * 1.01 = $3.03 MM
With Multiple and growth
3.03 * 21.7 = $65.8 MM
With Multiple and no growth
3 * 17.9 = $53.7 MM
Summary
4
Market Today
Description
Cap Rate
Office: Downtown office, prime towers, well located, well designed, top of the market, big
building, lots of quality tenants, smooth lease expiration
7-8
Office: Suburban, good, smaller, fewer tenants, not as well located, not quite as
liquid.
7.5-9
Office: Second tier city, suburban, small, two tenants, medium quality credit tenants, less
liquid, lumpy lease expiration
Comment: There is a large spread on the second tier office buildings. The city in which the
property is located will have a significant impact on the property’s cap rate.
8.5-12
Garden Apartments (A quality): Good location, recent design, (less visibility
because no individuals will have credit, but the group does– these are individuals not
companies occupying)
7-8
Ga