Using Cap Rates to Evaluate Commercial Property prices

As a Commercial Lending professional, I often begin my conversation with a real estate investors or commercial buyer when there is a real estate sales contract already executed. 

While most of us are familiar with the process in purchasing a home and a basic understanding of market valuations and comparable sales, commercial property is an entirely different matter.

Commercial property, other than residential property bought for ‘buy and flips,’ is valuable primarily because of the income that it produces.  For example, apartment buildings generate rental income, retail stores generate sales and if purchased as an investment, rental income as well.

So how much is a commercial building worth?   Commercial buildings in nice areas, facing parks and having a nice view only have more ‘value’ than commercial buildings without these amenities, if they are able to generate more income for the investor.  

The measuring rod with commercial properties is something called “Cap Rate,” which is short for “Capitalization Rate”.   A cap rate is quite simply the rate of return expressed in a percentage that a commercial property generates.   Investors, lenders and shareholders prefer higher cap rate to lower ones. While cap rates vary by location, property condition and market trends, a wise investor determines a property's value based on a desired cap rate.

While text book examples of calculating acceptable cap rates can become very complicated and always take into consideration vacancy rates, management fees, etc., the simple formula for a building's cap rate is net operating income divided by sales price.

An apartment building, for example, that generates net operating income (prior to loan coverage) of $98,000 annually that is for sale for $1,100,000 provides a cap rate of 8.9%  

Here’s an easy way (i.e. fast-n-dirty) to quickly determine a commercial property’s value.  Take the net operating income (prior to the new loan coverage) and divide it by .10     While 10% may be high in some areas and low in others it does remind the investor that they need to cover their cost of capital plus make a decent return (i.e. 3+7; 4+6 etc.).    The math is easy as you just move the decimal over (i.e. $98,000 annual income with a cap rate of .1 = $980,000 market value of the property).

Stand Your Ground

There are many promises of Jesus that we can find in the Bible. While there are over 200, here are just a few: He promised that He would die and in three days rise from the dead.

He promised He would send the Holy Spirit and that He would come back again. He promised that He would draw all to himself. And finally but not least, He promised his followers that they would be hated and persecuted.                                                                              

Jesus said,

“I am sending you out like sheep among wolves. Therefore be as shrewd as snakes and as innocent as doves. Be on your guard; you will be handed over to the local councils and be flogged in the synagogues. On my account you will be brought before governors and kings as witnesses to them and to the Gentiles."  

"But when they arrest you, do not worry about what to say or how to say it. At that time you will be given what to say, 20 for it will not be you speaking, but the Spirit of your Father speaking through you."  

“Brother will betray brother to death, and a father his child; children will rebel against their parents and have them put to death. You will be hated by everyone because of me, but the one who stands firm to the end will be saved. When you are persecuted in one place, flee to another. Truly I tell you, you will not finish going through the towns of Israel before the Son of Man comes." (Matthew 18:16-23)

Jesus tell us that we will be handed over, flogged, brought before governors and kings. We will be arrested, betrayed, hated and put to death. However, He tells us to 'stand our ground.' When we hear of 'Standing your ground' we may think about self-defense or being assertive or exercising our rights. However, this is not what Jesus means as this is all about our witness and our faith.

The context of the above verses is the 10th chapter of Matthew. Jesus is providing final instructions to His disciples. Jesus has been teaching them for three years and he's about to send them out. They have been following but soon will be on their own; He's giving them their job description. Just prior to these verses Jesus says, “The kingdom of heaven has come near. Heal the sick, raise the dead, cleanse those who have leprosy, drive out demons. Freely you have received; freely give.”(Matthew 10:8)

That’s a great charge to these disciples! Some commentators have said that this chapter 10 of Matthew is the disciples’ ordination ceremony. For those that may be unfamiliar, let me provide some insight.

Ordination is ‘setting apart the individual for the work of the ministry’. For churches and denominations that take this process seriously, there are very similar steps or processes. It begins with a selection process, an examination of the individuals, and then an examination of the individual’s credentials – typically both practical as well as academic or theological training. Finally, the candidate kneels and others that have gone before, often the elders and pastors, lay hands on the candidate.

I still remember the charge I was given when I was ordained: I was told to: 1) Love God,  2) Love His Word, and 3) Love His People. While there were a number of scripture verses that were recited during the service, one of the verses that was emphasized was in Acts 20:28-31

“Keep watch over yourselves and all the flock of which the Holy Spirit has made you overseers. Be shepherds of the church of God, which he bought with his own blood. I know that after I leave, savage wolves will come in among you and will not spare the flock. Even from your own number men will arise and distort the truth in order to draw away disciples after them. So be on your guard!”

I believe that that these verses in Acts 20:28-31 that are similar to Jesus instructions above in Matthew 18 are valuable instructions as well as warnings for ALL of us. Jesus said that while people are offered light, they will prefer darkness because their deeds are evil. That evil in the hearts of those that prefer darkness leads to the trials, the persecutions and the hate. When these attacks come, it can easily lead to compromise, silence, withdrawal and capitulation and surrender.

Our response however is to stand firm. We are to acknowledge Jesus before men and are promised that Jesus will acknowledge us before His father. We have the truth that sets people free, we are the light in the midst of darkness.

Stand your ground!

Following Jesus

Jesus said we are to follow Him.   Following Him may mean more than what we may think.

Scripture Matthew 8:19-22
"Now when Jesus saw a crowd around him, he gave orders to go over to the other side. And a scribe came up and said to him, "Teacher, I will follow you wherever you go." And Jesus said to him, "Foxes have holes, and birds of the air have nests, but the Son of Man has nowhere to lay his head." Another of the disciples said to him, "Lord, let me first go and bury my father." And Jesus said to him, "Follow me, and leave the dead to bury their own dead." 


While leadership training in the church has been the rage, we also need to learn what it means to follow. Jesus didn't specifically recruit leaders, He recruited followers.

It these verses, Jesus tells us what it means to truly follow Jesus.

When the teacher of the law came to Jesus and said, "Teacher, I fill follow you wherever you go." Jesus replied with this unusual response about foxes and birds and dens and nests.    This is a full unconditional commitment that is required by Jesus.   It's interesting to take note and to remember that all of the disciples literally left everything they had behind and followed Jesus along dusty roads, into distant places, through Judea, Samaria and Galilee, up mountain sides and across tumultuous seas.

How many of us are willing to follow Jesus but put conditions on where that may take us?   For those of us that can remember Scott Wesley Brown's song "Please don't send me to Africa" (Out of Africa 1998); we likely relate to the lyrics

Please don't send me to Africa
I don't think I've go what it takes
I'm just a man, I'm not a Tarzan 
Don't like lions, gorillas or snakes
I'll serve you here in suburbia
In my comfortable middle class life
But please don't send me out into the bush
Where the natives are restless at night 

Jesus also tells us that there is an urgency in his call to "Follow".   One of the disciples came to Jesus and said, "Lord let me go and bury my father".  Jesus reply to "leave the dead to bury the dead" has always seemed harsh and uncharacteristic of Jesus but is important.

All too often, likely because these words seems harsh,  Jesus response for immediacy or urgency is explained away.   I've heard it explained that the Jewish custom of burial included a "Shanah" a period of an entire year of morning that was being requested and Jesus replied with His request according to the "Shiva" that is only a maximum of seven days.    However, Jesus is not allowing even for seven days but simply says, "Follow Me."

Jesus wants us to follow but in his recruitment of his followers, He was more interested in quality rather than quantity. A famous British theologian of this last century, John Charles Ryle, said, "Nothing has done more harm to Christianity than the practice of filling the ranks of Christ's army with every volunteer who is willing to make a little profession, and to talk fluently of experience."

In these responses from Jesus we also see that Jesus is being brutally honest with his new recruits.   He wants them as well as us to know what it was going to be like to truly follow Him.   As the three-years with His disciples came to a close and the passion and crucifixion was before Him, it would require a complete and unconditional commitment on the part of His followers to make further disciples.  

One of the first teachings of Jesus is found in Matthew 3:2 as Jesus says, "Repent, for the Kingdom of God is at hand".    Interestingly, the very last words of Jesus recorded in the Bible are in the Book of Revelation 12:20 where Jesus reminds us, "Yes, I am coming quickly"

"Amen, Come Lord Jesus"