Going-in Cap Rate
The going-in cap rate is a real estate investment metric that measures the initial unleveraged rate of return an investor can expect from a property based on its first year's projected Net Operating Income (NOI) relative to its purchase price.
Key Takeaways
- The Going-in Cap Rate is calculated by dividing the property's projected first-year Net Operating Income (NOI) by its purchase price.
- It represents the initial unleveraged return on investment, providing a snapshot of a property's income-generating potential at the time of acquisition.
- Investors use this metric to compare the relative value and risk of different income-producing properties, assuming an all-cash purchase.
- Factors like market conditions, property type, lease terms, and economic outlook significantly influence a property's going-in cap rate.
- A lower going-in cap rate often indicates a lower risk and higher property value, while a higher rate may suggest higher risk or a value-add opportunity.
What is Going-in Cap Rate?
The going-in cap rate, also known as the initial cap rate, is a fundamental metric in real estate investment used to assess the potential return on a property at the time of acquisition. It provides an immediate snapshot of the property's income-generating ability relative to its purchase price, assuming an all-cash transaction without considering financing costs.
How to Calculate Going-in Cap Rate
Calculating the going-in cap rate is straightforward, requiring only two key figures: the property's projected first-year Net Operating Income (NOI) and its purchase price. The NOI represents the property's annual income after deducting all operating expenses but before debt service and taxes.
Formula
Going-in Cap Rate = Annual Net Operating Income (NOI) / Purchase Price
Importance in Real Estate Investment
The going-in cap rate is a critical tool for investors for several reasons:
- Property Comparison: It allows investors to quickly compare the relative value and risk of different income-producing properties in a given market.
- Valuation Indicator: A lower cap rate generally indicates a higher property value and lower perceived risk, while a higher cap rate suggests higher risk or a potential value-add opportunity.
- Investment Strategy: It helps align potential acquisitions with an investor's strategy, whether seeking stable, lower-risk assets or higher-yield, potentially riskier ventures.
Real-World Example
Consider an investor looking to purchase a multi-family property. The property is listed for $1,500,000, and the investor projects its first-year Net Operating Income (NOI) to be $90,000.
- Identify Annual NOI: The projected annual NOI is $90,000.
- Identify Purchase Price: The property's purchase price is $1,500,000.
- Calculate Going-in Cap Rate: Divide the NOI by the purchase price: $90,000 / $1,500,000 = 0.06.
- Convert to Percentage: The going-in cap rate for this property is 6.0%.
This 6.0% indicates that for every dollar invested, the property is expected to generate six cents of unleveraged net operating income in the first year.
Frequently Asked Questions
What is the difference between going-in cap rate and exit cap rate?
The going-in cap rate is used at the time of property acquisition, reflecting the initial return based on the purchase price and first-year NOI. The exit cap rate, conversely, is used to estimate the property's value at the end of the investment holding period, typically applied to the projected NOI in the year of sale to determine the future sale price.
Does the going-in cap rate account for financing?
No, the going-in cap rate is an unleveraged metric. It uses Net Operating Income (NOI), which is calculated before deducting debt service (mortgage payments). Therefore, it does not directly account for the impact of financing on an investor's actual cash-on-cash return.
What is considered a 'good' going-in cap rate?
What constitutes a 'good' going-in cap rate is highly dependent on market conditions, property type, location, and the investor's risk tolerance and investment strategy. Generally, lower cap rates (e.g., 3-5%) are associated with lower-risk, stable assets in prime locations, while higher cap rates (e.g., 7-10%+) might indicate higher risk or value-add opportunities in emerging markets or distressed properties. Investors typically compare a property's cap rate to prevailing market cap rates for similar assets.