The capitalization rate, commonly referred to as the cap rate, is the ratio of Net Operating Income (NOI) to a property’s value. For example, a property listed for $2,000,000 that generated an NOI of $140,000 would be offered at a cap rate of 7%.
Regretfully, there is considerable variance in how this is represented. Many commercial real estate practitioners will present NOI with no allowance for vacancy or management costs. Skipping over these NOI reducing realities tends to overstate income, causing a number to sound more attractive, but at the expense of clarity and credibility upon further review. In most if not all cases, an allowance should be made for each. More professional presentations tend to take these into account.