Capitalization Rate / Cap Rate

Direct market capitalization rates are rates established by market participants based on closed sales, the rate is the ratio of net operating income to the total sales price and it is expressed as a percentage.  Buyers want properties with a high cap rate since higher rates provide for higher net returns.  As an example, a million dollar property with a 6.0% cap rate returns annually about $ 60,000, while a million dollar property with a 10.0% cap rate returns $ 100,000 per annum.

Generally higher returns, and thus higher cap rates, are typically associated with older properties with relatively high risk, while newer, high-demand properties with less risk provide a lower return and a lower cap rate.  So real property investors must weight the risks and rewards of ownership, and cap rates usually reflect that relationship.

Direct market capitalization rates are calculated by dividing the net operating income (NOI) of comparable sales by their sales price (NOI / Sale Price).  When several recent, comparable sales are reviewed a relatively narrow range of capitalization rates is discovered.  Appraisers consider which properties are most similar, and a single rate is reconciled. 

Most direct market capitalization rates on improved real property in Clark County, Nevada in 2008 varied between 6.0% and 10.0%.  Properties providing net returns near 6.0% are newer, well-located, low risk properties with "durable" income streams, while properties with cap rates near or over 10.0% were older and have relatively more risk associated with their income production.

A yield capitalization rate is selected by the appraiser based on a consideration for historic yield rates and on rates anticipated by buyers and seller for similar investments.  The yield rate is selected based on appraiser judgment in the same way that an overall direct rate is selected from a range of rates provided by the market.  The physical, economic, financial and risk characteristics of comparable properties is also considered.

Appraisers utilize direct market capitalization rates and yield capitalization rates in the income approach sections of their appraisal reports.  They also consider comparable sales in the sales approach.  Replacement costs are considered, via a cost manual or through actual costs, together with land value in the cost approach.       

Contact us with your questions or concerns regarding capitalization rates or regarding your specific appraisal assignment in Nevada at 1-702-568-6699.  We can also be e-mailed at grigdon@cox.net.  

Commercial Real Estate Appraisals in the Las Vegas & Henderson, Nevada Area.