3. Capitalization (Cap) Rates
• Next Year’s “Stabilized” (flat, or growing
relatively smoothly) Adjusted Net Operating
Income/Purchase Price = Cap Rate %
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• An “8 Cap” is a Property with a Cap Rate of
8.00%, which is equivalent to a valuation
(Purchase Price) of 12.5x Next Year’s Stabilized
Adjusted Net Operating Income
>> Go To Excel tab: Sample Cash Flow Statement
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4. Net Operating Income vs. Adjusted NOI
Data Series
OPERATING INCOME Profile Total 2013 2014 2015 2016 2017
Gross Potential Rental Revenue $23,790,292 4,500,000 4,590,127 4,816,605 4,925,280 4,958,280
Vacancy ($365,404) 0 (45,901) (72,249) (98,506) (148,748)
Net Base Rental Revenue $23,424,887 4,500,000 4,544,226 4,744,356 4,826,774 4,809,531
Percentage Rents $355,869 93,305 66,210 66,926 64,003 65,425
Total Rental Income $23,780,756 4,593,305 4,610,436 4,811,282 4,890,777 4,874,956
Expense Reimbursements -1.15% -4.56% -1.02% -9.38%
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CAM Billings
Property Tax Billings
$2,098,620
$1,788,486
445,368
390,428
440,267
370,123
420,196
351,126
415,895
346,681
376,894
330,128
Ancillary Income $115,823 24,580 24,298 23,191 22,953 20,801
Gross Income $27,783,685 5,453,681 5,445,124 5,605,795 5,676,307 5,602,778
Credit Loss1 1.00% ($237,903) (45,000) (45,901) (48,166) (49,253) (49,583)
Total Operating Income $27,545,782 5,408,681 5,399,223 5,557,629 5,627,054 5,553,196
OPERATING EXPENSES
Reimbursable Expenses:
Common Area Maintenance ($2,412,257) (445,368) (463,183) (481,710) (500,978) (521,018)
Property Taxes ($2,114,684) (390,428) (406,045) (422,287) (439,178) (456,746)
Non-Reimbursable Expenses:
Insurance ($300,866) (55,548) (57,770) (60,081) (62,484) (64,983)
Utilities ($569,331) (105,114) (109,319) (113,691) (118,239) (122,969)
Management ($452,696) (83,580) (86,923) (90,400) (94,016) (97,777)
Total Operating Expenses ($5,849,834) (1,080,038) (1,123,240) (1,168,169) (1,214,896) (1,263,492)
NET OPERATING INCOME $21,695,948 4,328,643 4,275,983 4,389,460 4,412,158 4,289,704
CAPITAL & LEASING COSTS
Tenant Improvements ($311,299) (36,200) (57,629) (152,145) (46,696) (18,629)
Leasing Commissions ($205,810) (12,200) (41,722) (107,561) (25,567) (18,760)
Capital Expenditure Reserves ($653,806) (103,400) (323,565) (190,919) (24,947) (10,975)
ADJUSTED NOI $20,525,033 4,176,843 3,853,067 3,938,835 4,314,948 4,241,340
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5. Cap Rate Calculation
• Next Year’s “Stabilized” (flat, or growing relatively
smoothly) Adjusted Net Operating Income/Purchase
Price = Cap Rate %
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This Year Next Year
Net Operating Income $1,900,000 $2,000,000
Today's Purchase Price $25,000,000
$2,000,000
Cap Rate = = 8.00%
$25,000,000
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6. Cap Rate and Valuation Multiple Reciprocal Relationship
NOI
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Cap Rate Multiple
5.00% = 5/100 Reciprocal = 100/5, which = 20.0x
8.00% = 8/100 Reciprocal = 100/8, which = 12.5x
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7. Cap Rates Continuum
"High" "Low"
Cap Rates 12% 11% 10% 9% 8% 7% 6% 5% 4%
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"Compression" of Cap Rates
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8. Cap Rates and Equivalent Multiples
"High" "Low"
Cap Rates 12% 11% 10% 9% 8% 7% 6% 5% 4%
"Compression" of Cap Rates
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"Expansion" of Multiples
Multiples 8.3x 9.1x 10.0x 11.1x 12.5x 14.3x 16.7x 20.0x 25.0x
"Low" "High"
Purchase Price $16,667 $18,182 $20,000 $22,222 $25,000 $28,571 $33,333 $40,000 $50,000
on $2MM of NOI
($000s)
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9. Back Solving Using Cap Rates
Property Valuation
Net Operating Purchase Price Capitalization Valuation
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Income EDIT Rate Multiple
$2,000,000 $40,000,000 5.00% 20.0x
$2,000,000 $25,000,000 8.00% 12.5x
$2,000,000 $20,000,000 10.00% 10.0x
$1,250,000 $25,000,000 5.00% 20.0x
$2,000,000 $25,000,000 8.00% 12.5x
$2,500,000 $25,000,000 10.00% 10.0x
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10. Quoted Cap Rate Reconciliation
• Was it a 6 Cap or a 7 Cap?
• The Seller says they sold at a 6 Cap
CLICK The Buyer says they bought at a 7 Cap, meaning that the
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first year’s NOI/Purchase Price will yield them 7%
• Since the purchase price (denominator of the equation) is
what it is, the discrepancy in the math stems from the
numerator (NOI)
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11. Quoted Cap Rate Reconciliation
• Ask them nicely: How are you defining NOI?
• Is it Stabilized NOI? How do you define that?
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• Is it before or after Normalized Capex?
• What Normalized Capex did you assume?
• Is it before or after Normalized TIs?
• What Normalized TIs did you assume?
• Is it before or after Normalized Leasing Commissions?
• What Normalized LCs did you assume?
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13. Capitalization (Cap) Rate Composition
Risk-free rate 1.50% U.S. Treasury
Property occupancy level 1.00%
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Quality 1.00% Subjective
Age 1.00% Subjective
Location 1.00% Subjective
Tenant mix and credit 2.00% Subjective
Total Cap Rate 7.50%
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14. Capitalization (Cap) Rate Composition
Risk-free rate 1.50% U.S. Treasury
Property occupancy level 1.00%
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Quality 1.00% Subjective
Age 1.00% Subjective
Location 1.00% Subjective
Tenant mix and credit 2.00% Subjective
Total Cap Rate 7.50%
A 600 basis point (6%) Spread To Treasuries Is Estimated
>> Go To Excel tab: Cap Rate Composition & Calc’n
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