How to Calculate Commercial Investment Ratios
The investment ratio commonly used to assess commercial property is known as the capitalization rate, or cap rate. The cap rate is an annual figure that shows the relationship between building costs and the rental income received. The higher the cap rate, the shorter the length of time required to recoup costs.
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Instructions
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Obtain the data needed for your calculation. You only need two items of information: the annual net operating income and the cost. The former represents the annual income after operating costs are deducted but before any interest or income taxes are taken away. The latter is the price paid for the commercial property. It should be noted, however, that this price should reflect current prices, not historical ones. So, if you bought your property 30 years ago, you should revalue the property to reflect the current market.
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Divide the annual net operating income by the cost in order to obtain the capitalization rate, which is the ratio that represents the rate at which costs are recouped from its income. Multiply the result by 100 to express the cap rate in percentage terms. For example, if you bought an office block for $1 million and the annual rent minus expenses was $50,000, your capitalization rate for the building would be 5 percent.
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Interpret your capitalization rate by comparing other investment properties in the area of the same quality. If cap rates differ, neighboring properties are either charging different rents or the buildings differ in value. If this is the case, it is possible your building has been valued incorrectly, especially if you are charging market rental rates.
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