Rob Rowsell answers a question from a caller about commercial real estate cap rates. Rob follows up with a deep dive on capitalization rates in the property investment industry. Watch and read along to learn everything you need to know in this cap rates deep dive!

Commercial Real Estate Cap Rates And Property Values Explained

Our caller Deon asked if a “6” cap rate was ideal before making an offer. Rob clarified that his initial example was based on a “6” rate. Really, Rob views that number as a starting rate when making a quick valuation, then you will want to dig deeper to see if you can do better. Depending on the situation, another rate could work better. Many factors, from the market to the broker, could affect what rate you want.

What formula do you use to determine a commercial property value?

Rob explains that this formula differs from the one we use for multifamily property values. In that situation, you compare recent sales near the dwelling you’re looking at. When looking at a commercial property, you can divide the Net Operating Income (NOI) by the Market Cap (Capitalization) Rate. You will then arrive at the value of the commercial property.

For example, you pay $1 million cash for a property. It brings in $100,000 in Net Operating Income. Therefore, you paid a “10” cap for that property. A more realistic scenario would be paying $1.7 million cash, bringing the cap rate to 5.8 – thus, Rob’s initial example rounded up to 6.

When you take the time to calculate realistic numbers, you will know whether or not a property is worth your time. Do your due diligence, because commercial investments can be risky business, even for seasoned pros!