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What Is A Cap Rate?

Cap Rate is short for Capitalization Rate.

The definition of Cap Rate, per the Third Edition of Dictionary of Real Estate Appraisal, is “any rate used to convert income into value”. Cap Rates are a valuation tool used to compare returns on investment real estate that may vary in rent rates, construction, location and a myriad of differences that typically occur between two properties. Cap Rate also is an indication of what return an investor is seeking and is willing to pay when acquiring a self storage facility.

HOW TO DETERMINE CAP RATES

Cap Rate is calculated by dividing the Net Operating Income (NOI) by the sales price. So, if you take your gross income generated by the property, subtract all normal operating expenses, excluding depreciation and loan payments, you get your NOI.

Divide the NOI by the sales prices and you have a Cap Rate expressed as a percentage:
• Cap Rate = NOI / Sales Price
• Gross Income – Normal Operating Expenses = NOI
Conversely, you can determine a value by applying the appropriate Cap Rate to your NOI. The formula is:
• NOI / Cap Rate = Sales Price

UNDERSTANDING EXPENSES WHEN DETERMINING NOI

Investors and bankers are going to insist that the expenses you use to determine NOI are what a normal operator would experience. The normal operating expenses includes monies for repairs, maintenance, lawn care and snow removal, off-site management fees and on-site staffing. You may handle some of the identified expenses on your own but the typical investor is going to outsource these expenses. Additionally, you must include a reserve fund for future capital expenditures.

Standard Operating Expenses Include:

• Property Taxes
• Insurance
• Payroll
• Management Fees
• Utilities
• Advertising
• Office Expense
• Lawn Maintenance
• Snow Removal
• Repairs
• Reserved Fund for Future
• Capital Expenditures

EXAMPLE

Let’s look at an example. Say your facility has a gross income of $550,000. Your operating expenses are $200,000. Gross income less expenses equals a NOI of $350,000. Let’s say that your self storage broker says that facilities of your size, condition and location are selling for 8.00% Cap Rates.

To figure out the value of your self storage property, we take the NOI divided by the Cap Rate of 8.00%:
(Cap Rates are expressed as a percentage, so divide by 0.0800)
• $550,000 – $200,000 = $350,000
(Gross Income – Normal Operating Expenses = NOI)

If Cap Rates in your area are 8.00%, use 0.0800:
• Then $350,000 / 0.0800 = $4,375,000

The value estimate equals $4,375,000 for your self storage property.

Determining the value of your self storage asset isn’t difficult, provided that you use the recommended methodology outlined above. However, working with an experienced real estate broker who focuses solely on the self storage industry is the best path for identifying an accurate value. An experienced self storage broker will be able to identify current Cap Rates, ways to improve NOI, provide an unbiased opinion of value and the current climate of the market. As the owner of a valuable self storage asset, it’s important to work with a professional who will help guide you through the valuation process and provide you with sound advice.

If you are looking to buy or sell a self storage asset, contact us today to get started with a free consultation.

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