A pricing ratio for property income
A capitalization rate relates a property's NOI to its price or estimated value. Dividing income by price produces the rate; dividing income by an assumed rate produces an estimated value. Keep trailing and forward income distinct. The ratio describes a property before the owner's financing structure and does not equal a REIT shareholder's dividend yield or total return. A high cap rate may reflect more income per dollar paid, but the durability and future cost of that income still require investigation.
Hypothetical arithmetic: the same income, different prices
A property generating $5 million of annual NOI at a $100 million purchase price has a 5% cap rate. If buyers require 6% for the same income, the implied value is $5 million / 0.06, or approximately $83.33 million. If NOI also falls 10% to $4.5 million, the implied value at 6% becomes $75 million. These examples ignore transaction costs and future spending. They illustrate the formula, not a predicted market move or an investment recommendation.
Make comparisons economically similar
Before comparing two advertised rates, ask whether both use the same income period, occupancy assumption, reserve policy, and transaction-cost treatment. A stabilized warehouse and a half-empty office building are not comparable merely because both have annual rent. Tenant credit, local supply, remaining lease term, capital needs, and rent relative to the market can change the interpretation. A seller's projected NOI may depend on renewals or expense savings not yet achieved. Recalculate using a clearly identified current-income case as well as the projection.
The acquisition-spread debate
A buyer may highlight the spread between an acquisition cap rate and borrowing cost. That spread can be informative, but debt is not the only capital source and interest is not the only cost. Corporate overhead, equity issuance, leasing investment, and transaction expenses also matter. The optimistic view emphasizes contractual increases and operating improvements. The skeptical view asks whether the initial yield compensates for tenant failure or obsolescence. Examine both the first-year economics and a stressed renewal period before describing a purchase as accretive.
Build and verify a sensitivity table
Read an issuer's transaction announcement and supplemental disclosures for how acquisition yield is defined. Compare those disclosures with the financial filing's lease and expense policies. Use a table that varies both NOI and cap rate, since weak income and higher required returns can occur together. Keep the calculation separate from a forecast. Small rate changes can materially alter value, and a valuation based on an assumed rate is not evidence that buyers will actually pay that price in a difficult market.
A common mistake
Subtracting an interest rate from a cap rate does not calculate the shareholder's total return.
What to check in the disclosures
- Match income periods and assumptions.
- Check whether NOI is achieved or projected.
- Include future leasing and capital costs.
- Stress income and cap rate together.
Sources & scope
This guide focuses on US REITs. Examples are hypothetical unless explicitly attributed. Definitions and issuer disclosures can change; use the current source and the issuer's own reconciliation.
Educational material, not a recommendation or personalized investment advice. How these guides are prepared · Report a correction