A property's stabilized net operating income divided by its price or value. Divide income by the cap rate and you get an estimate of value.
The OCC handbook defines the cap rate as the ratio between a property’s stabilized net operating income and its sales price. Turned around, it is how appraisers value income property: in direct capitalization, value equals net operating income divided by the cap rate.
Example: a building that earns $140,000 a year and sells for $2,000,000 traded at a 7 percent cap rate. The same $140,000 valued at 8 percent is worth $1,750,000, a drop of $250,000 with no change in income.
That sensitivity is why the term matters to a borrower. The handbook notes that rising interest rates may lead to higher cap rates and so to lower values, which raises loan to value on a loan that has not changed. A lender does not pick the cap rate. The appraiser derives it from recent sales of similar properties, and the lender’s review appraiser checks it. HUD’s guide for multifamily underwriters adds a reasonableness test: a cap rate should generally exceed the mortgage constant.
How it shows up in the data here
Not in any public file. No lender filing here carries a cap rate or an appraised value. A cap rate reaches a loan through the appraisal, which sets the value behind loan to value. Use the LTV and LTC calculator to see how a change in value moves the ratio.
Go further
- LTV and LTC calculator: Loan to value at the value you enter.
- Debt yield calculator: A loan measure that does not depend on the cap rate.
- LTV and LTC calculator: Loan to value and loan to cost, the equity a lender will ask for, and the federal supervisory limit for the property type.
- Debt yield calculator: Cash flow over the loan. The one ratio that ignores the rate, the amortization and the cap rate.
- How bankers evaluate a commercial loan deal: A credit officer asks one question five ways: how will this loan be repaid, and what happens if it is not? Knowing the five tests lets you size a request before you send it.
Related terms
- Net operating income (NOI): A property's annual income minus its operating expenses, before loan payments, income taxes and depreciation. It is the top number in DSCR and debt yield.
- Appraisal: A written, independent opinion of a property's market value as of a specific date, prepared by a qualified appraiser.
- As-is value: The market value of a property in its actual physical condition, use and zoning on the appraisal's effective date, with no credit for planned work.
- As-stabilized value: An appraiser's estimate of what a property will be worth on the future date it is projected to reach stabilized occupancy.
- Loan-to-value ratio (LTV): The loan amount divided by the value of the property securing it. A $700,000 loan on a property valued at $1,000,000 is 70 percent loan to value.
- Debt yield: Net operating income divided by the loan amount, shown as a percent. It measures how much income stands behind each dollar lent, whatever the rate or term.
- Loan constant: One year of loan payments divided by the loan amount, shown as a percent. It folds the interest rate and the amortization period into a single number.
Sources
Plain definitions for orientation, not legal, tax or credit advice. A lender's own policy decides what it will do.