Glossary / Space and measurement
Also known as: Capitalization rate
A ratio of a property's net operating income to its value, used to compare and value commercial real estate. Dividing NOI by the cap rate gives an estimated value, so the rent you lease space at flows directly into what a building is worth.
Wikipedia defines the capitalization rate as a real estate valuation measure used to compare investments, calculated as net operating income divided by property value. Rearranged, property value equals NOI divided by the cap rate.
If NOI rises while the cap rate stays the same, value rises in proportion. A lower cap rate, which reflects lower perceived risk, also raises value for the same income. Cove gives the example that $1,200,000 of NOI at a 6 percent cap rate implies a value of $20,000,000.
Leasing brokers do not set cap rates, but the leases you sign change the Net operating income (NOI) that cap rates are applied to. That is why owners care so much about rent levels, concessions, and vacancy, and why a well-leased building can be sold or refinanced on better terms.
A sale or refinancing can also affect the timing of your pay. If a building is sold while commission installments on your lease are still outstanding, who owes them depends on your commission agreement and the sale documents. A sale or refinancing is a good moment to confirm in writing what is still owed to you.
When you present a lease to an owner, translate the added income into added value at the market cap rate the owner uses.
For example, a hypothetical building earns $2,000,000 of NOI. At a hypothetical 7 percent cap rate, it is valued at about $28,571,429. A new lease that adds $150,000 of annual NOI raises NOI to $2,150,000 and the value to about $30,714,286, an increase of about $2,142,857.
