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# What Is a Cap Rate and How Do You Calculate It?

The capitalization rate, also known as Cap Rate, is mostly used in commercial real estate to
indicate the rate of return. However, it can also measure the level of risk that a commercial
real estate property carries. And we all know that risks are always involved when it comes to
real estate investments.

Essentially, it is a mathematical formula used to calculate the ROI (Return on Investment) you
would expect to receive from a property you plan to purchase.

Calculation Example: If the current market value of a property is \$1 million and it has a NOI
(Net Operating Income) of \$70,000, then the cap rate is 7% or \$70,000 ÷ \$1,000,000 = 7%.

### What Does This Calculation Actually Mean?

It generally means the lower the cap rate, the lower your risk. Different cap rates between
properties represent different levels of risk, and each asset type typically trades within its own
cap rate range.

• A multi-tenanted stabilized retail property might trade between a 6-9% cap rate.
• A stabilized multi-family property will trade anywhere between a 4-6% cap rate.

Multi-family assets consistently have among the lowest cap rates within a market because they
are considered to provide lower risk compared to other asset types.

When analyzing a potential investment property to determine the right cap rate, you should
consider several factors such as location, asset type, and the current interest rate.

As an investor, the challenge is to determine the right cap rate given the riskiness of the deal.
Now that you know what a Cap Rate is and how to calculate it, are you going to use it?

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