UNDERSTANDING CAP RATES
by John H. Gilliland
If you are planning to sell or purchase a self storage
facility, your real estate broker will talk to you about
values in terms of cap rates. If you are an owner looking
to refinance a facility, your appraiser will use cap rates to
determine a value. What exactly are cap rates, and how
do we determine them? Why do we use cap rates in the
first place? What cap rate is the current market using?
This article will answer these questions and help you
understand and use cap rates.
WHAT IS A CAP RATE?
Cap rate is short for capitalization rate. The definition of
cap rate per the Third Edition of Dictionary of Real Estate
Appraisal is “any rate used to convert income into value”.
Cap rates are a valuation tool used to compare returns
on investment real estate that may vary in rent rates,
construction, location, and a myriad of differences that
typically occur between two properties. Cap rate also is
an indication of what return an investor is seeking and is
willing to pay when acquiring a self storage facility.
HOW TO DETERMINE CAP RATES
Cap rate is calculated by dividing the Net Operating
Income (NOI) by the sale price.
So if you take your gross income generated by the
property, subtract all normal operating expenses,
excluding depreciation and loan payments, you get your
Divide this NOI by the sale price and you have a cap rate
expressed as a percentage. Cap rate = NOI/Sale price.
Conversely, you can determine a value by applying the
appropriate cap rate to your NOI. The formula is:
Just a note about calculating NOI. Investors and
bankers are going to insist that the expenses you use to
determine NOI are what a normal operator would
experience. This includes monies for repairs,
maintenance, lawn care and snow removal even though
you may do some or all of these yourself, an off-site
management fee in addition