Short answer: A capitalization (cap) rate is the market rate of return buyers expect from an asset type. Appraisers use it to turn net operating income into a value: value = NOI ÷ cap rate. Mark’s warning is that the “cap rate” in a marketing package is rarely a real one, so buyers should calculate their own NOI.
How appraisers use it #
An appraiser calculates NOI from the last calendar year or trailing 12 months, then divides it by the cap rate buyers expect for that type of asset in that market.
Illustration only: $350,000 of NOI at a 7% cap rate implies a value of $5,000,000 ($350,000 ÷ 0.07). At 6.5%, the same NOI implies about $5.38 million. A small change in cap rate makes a big change in value.
Why it’s misunderstood #
- Offering memorandums often show cap rates built on income and expense numbers that won’t hold up. Mark never relies on them.
- Buyers should work out their own NOI: start from current income, then set expenses based on how they will actually run the facility (advertising, staffing, likely property tax increases and so on).
- Smaller buyers rarely make a stabilized facility work at market cap rates. Mark usually decides what he can pay based on returns after his value-add plan, using cash-on-cash and IRR, and uses cap rates mainly to project future value in his pro formas.
Related answers #
- How is net operating income (NOI) calculated for a self-storage facility?
- What is the difference between cash-on-cash return (ROI) and IRR in self-storage?
- Why should you set benchmark returns before looking at self-storage deals?
Source: Mark’s post Cap Rates, ROI, IRR – Which Matters Most in Self-Storage?
