What Are Factors That Influence Cap Rates? 

If you are thinking about investing in real estate, one of the first things you have to look at is the capitalization rate, also known as the cap rate. These rates are the ratio of a property’s net operating income to its original cost. The higher the cap rate, the lower the purchase price. The truth is that there are so many different factors that go into calculating these influential investment rates, which is why it’s important to work with a trusted broker at Calkain.

Here is the Cap Rate Formula for Net Lease Properties:

Capitalization Rate = Net Operating Income / Purchase Price

Net Operating Income (NOI) is the expected income generated by the property with all of its property management expenses deducted.

Purchase Price is how much the property was purchased for.

Other factors also influence these rates:

  • Age of the property and location
  • Property type
  • Credit worthiness of the tenant
  • Term and structure of the lease
  • The market and the available inventory

Age of the Property and Location

The age of the property matters when deciding the cap rate. Newer constructions obviously fetch a higher price point. New constructions are also longer leases compared to older constructions. This could benefit a buyer or a seller.

Where a property is located it can also have a big impact. People are willing to spend more money on property that are in bigger cities because they are closer to high-paying jobs and entertainment. Dense retail usually draws out credit-worthy tenants and that national chains. This means that the investment will be safer for the investor/landlord as they would be having a constant cash flow. The same could be said for a seller. The property will draw a higher price in a denser location.

Property Type

Normally when deciding on what to invest in, investors look at the property type. Properties can be residential, industrial, retail, or office can affect the investment. For example, single tenant net lease (STNL) properties are generally safe investments that come with a stable cash flow and are safe for investors. Residential/rental properties need constant maintenance and sometimes you have a vacancy which jeopardizes your monthly income from the property. With a net lease, STNL, or retail property you normally have a tenant who is in the space for the long-term and has a reliable source of income and sometimes a corporate guarantee. Investments with low risk make for beneficial investments to your portfolio. This also means the risk effects the cap rate.

Credit Worthiness of Tenants

A credit tenant is usually a business with a national footprint, a large regional tenant, or a local tenant with excellent credit that may be better than their national competitors. Only larger companies are called credit tenants. A lender will offer better financing terms for a development with a certain amount of space preleased or currently leased to credit tenants.

Term and Structure of the Net Lease

As we are net lease brokers, we focus on this market. It is important to remember that your rates could also be influenced on the type of net lease you have. Ground Leases/Absolute NNN properties have the least amount of risk followed by Double Nets and then (rare) Single Net properties.

Triple Net properties are usually single tenant net leases not to be confused with “N” leases or single net leases. This means that there is one occupant that pays all of the bills to maintain the operations of the business as well as the property. We see double net leases usually in the case of multi-tenant leases. This means the owner is usually responsible for the roof and structure and this one factor can influence the cap rate. Single net leases are riskier and often bring a higher rates along with them.

The Market and the Available Inventory

When you are looking to invest in property, you also have to consider how many properties are available in the area you want to buy in. for example if you want to buy a McDonald’s in an area where they are in high demand, the cap rate would be lower, but the price would be higher.

When Should You Use the Cap Rate?

It is important to use these as a way to analyze a piece of real estate you are thinking about investing money into. You can use these rates for commercial buildings, apartment buildings, multifamily rental properties, townhomes and several other types of properties. Ideally, you’ll want to determine the capitalization rate before you agree to any terms.

Cap rates are a beneficial component to understanding the worth of a potential or current commercial property. However, it isn’t the only factor that you should consider. Working with a brokerage firm like Calkain will help you evaluate the market and all of the other components when it comes to investing in real estate. If you need assistance in determining the cap rate of your property, just curious on how much it is worth, or even looking to buy, the experts at Calkain are ready to help.

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