If you don’t have the cap rate but you have your NOI how would you find your cap rate?
Technical question here: let’s say you know how much the property is producing from an NOI perspective. What are the valuation steps to take to find your Cap rate?
Take my answer w a grain of salt as I am a college student still learning about real estate investments but:
1) If you know the net operating income AND the value of the building, then you can divide the NOI/value of the building to come to a cap rate (the easiest way to get a cap rate but the hard part is trying to find out how much the building is even valued at. To get this, check below)
2) You can use the sales comp approach to compare similar buildings in the market and see what cap rates they're trading at. This can be done not only to see what cap rates are for similar buildings but also how much other buildings are worth as well (value of the building). Avg them and use the following equation (NOI/Value of the building) to get a rough estimate of the cap rate.
You determine what IRR you need to hit in order to make the deal work, and then you set the exit cap in your model so that you hit it.
Divide NOI by value of the building. If someone is saying that they'd buy/sell the property at $10M and the NOI is $1M then the cap rate is 1/10 or 10%.
In the real world what will happen during a transaction is that a seller will say "I want $100M for this apartment complex and based on the current NOI and these projections we think the NOI will be $6M in year 1, so the cap rate you'd be buying this building at is 6% and that's a great deal!". Then once you get your hands on their financial statements and make your own assumptions (because brokers/sellers always overstate the upside), you underwrite the property to having a $5.5M NOI in year 1. Well that means that based on your assumptions they are asking for a 5.5% cap rate. This is where the negotiations start to happen and you then offer prices based on the cap rate that you want to buy at. For instance, if you underwrite a $5.5M NOI and still want to buy it at a 6% cap rate, then you would offer the current owner $91.67M.
Cap rates aren't really a set in stone way to value a property, and more so a representation of the unlevered, un-trended yield that someone would get if they bought the asset at a certain price.
Good explanation.
Also worth noting that a cap rate, as a metric, has no intrinsic value. It's a guidepost to let you know whether you're underpaying or overpaying for an asset when set against comparable properties. Industrial buildings in New Jersey will probably trade within a certain range of cap rates, but that doesn't mean you can't do better with something trading at a tighter cap, if you have a business plan to execute on that will raise NOI. It's just shorthand for "this is about how much assets trade for." Cost of debt will also massively impact cap rates, which again implies that the rate isn't necessarily tied to the value of the asset being purchased, but a market-wide approximation of what that asset class is worth
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