Cap Rates, NOI and What a Building Is Actually Worth

Capitalisation rate is net operating income divided by price. A building producing $90,000 of NOI at a 7% cap rate is worth about $1.29m. Reverse it and a purchase price implies a cap rate. That is the entire formula.

Why it is useful

It lets you compare buildings of different sizes and types on one axis, and it links value directly to performance. Add $10,000 of NOI at a 7% cap and you have added roughly $143,000 of value — which is why operational improvements matter more in commercial than cosmetic ones.

Why it is misused

• NOI is quoted before capital expenditure, which is not optional
• Sellers present pro forma NOI — what the building could earn — as if it were actual
• Management fees are often omitted when an owner self-manages

Always rebuild NOI yourself from the operating statements before applying a cap rate to it.

Cap rate is not a return

It is an unlevered yield at a point in time. It says nothing about your financing, your tax position or your holding period. Two buyers paying the same cap rate can have completely different outcomes.

What moves cap rates

Interest rates, perceived risk, and the local supply of buyers. When borrowing costs rise, cap rates generally follow, which means values fall even if the building performs exactly as before.