Cap rates (capitalization rates) are still one of the most-mentioned and least-understood elements of commercial real estate.
What is a cap rate?
The simplest way to define a cap rate is to say that it’s the percentage that results from dividing an operating property’s income by its purchase price. While this is true, that definition’s vagueness might do more harm than good in many cases, as nuance is critical in understanding cap rates as they relate to income-producing commercial real estate properties, namely:
How is the person reporting the cap rate defining “income”?
When we refer to property income (the numerator of the cap rate ratio), we might be referring to several different things:
- Trailing Twelve Months (“TTM” or “T12M”) Net Operating Income (NOI)
- Trailing Twelve Months Adjusted Net Operating Income
- Forward (projected as of the time of purchase) Twelve Months Net Operating Income
- Forward (projected as of the time of purchase) Twelve Adjusted Months Net Operating Income
- tenant improvements (TIs)
- leasing commissions (LCs)
- capital expenditures (Capex)