What is a cap rate?
A cap rate, or capitalization rate, is the ratio between a property's stabilized net operating income and its sales price. Direct capitalization divides that income by the rate to estimate value, which suits income that is stabilized and expected to stay stable. Cap rates move with the returns investors and lenders require, and no public source publishes one for Carroll County, Virginia, or the counties around it.
Steady income set against price, and why the word stabilized carries the definition
Stated in words, a cap rate compares two things: the net operating income a property produces once its income has settled into a steady pattern, and the price the property sells for. The federal bank regulator's handbook on commercial real estate lending puts it in a single line.
The ratio between a property’s stabilized NOI and the property’s sales price to convert income into value.
Office of the Comptroller of the Currency, Comptroller's Handbook, Commercial Real Estate Lending
NOI is net operating income: what the property earns from running it, after the costs of running it. The same glossary entry says a capitalization rate is sometimes called an overall rate, and the handbook it comes from is Version 2.0, dated March 2022.
The word that does the work is stabilized. A ratio of income to price only says something about value if the income is the kind that will keep arriving. A building halfway through filling its space, a property coming off a year with an unusual expense, or an operation whose income swings from one period to the next does not have a stabilized income yet, and a ratio built on a single year of it would describe that year rather than the property.
That is why two properties with the same income last year can carry very different cap rates. One has a record that shows the income repeating. The other has a number that may not come back.
Direct capitalization divides income by the rate, and discounted cash flow takes the rest
The handbook describes two ways the income approach turns expected future income into a present value: direct capitalization and discounted cash flow analysis. The cap rate belongs to the first.
This is accomplished by dividing the NOI by the capitalization rate. This method is appropriate when applied to a stabilized NOI and the future income stream is expected to be stable.
Office of the Comptroller of the Currency, Comptroller's Handbook, Commercial Real Estate Lending
The arithmetic runs in one direction worth remembering. Hold the income steady and raise the rate, and the value that comes out goes down. Lower the rate, and the value goes up. The rate is the lens the income is read through, so a change in the rate moves the value just as surely as a change in the income does.
Discounted cash flow is the other tool, and the handbook calls it useful for valuing properties that have not reached stabilized occupancy or that are expected to see material swings in income. It projects the income year by year rather than capitalizing one figure. An operating lodging business is a property where the real estate, the furnishings and the business itself each carry value, and how that kind of sale is put together is covered in how an inn or lodging property is sold.
Raw land usually has no income to capitalize at all. Land a developer means to build on is priced by working backward from what the finished lots would bring, which is explained in how developers decide what to pay for land.
Interest rates can change the rate while the building stays exactly the same
A cap rate is not a fact about the property the way its acreage is. It is a judgment about the return money requires, and the handbook says where that judgment is supposed to come from.
The discount and cap rates used in estimating property income and values should reflect reasonable expectations for the rate of return that investors and lenders require under normal, orderly, and sustainable market conditions.
Office of the Comptroller of the Currency, Comptroller's Handbook, Commercial Real Estate Lending
Read that as two limits. The rate tracks what investors and lenders require, not what an owner hopes for. And it is meant to reflect orderly conditions, not a market that is disorderly or cannot last.
The handbook then names the effect an owner feels most directly: rising interest rates may lead to higher capitalization rates and lower property values without any change to the property's own fundamentals. Nothing about the roof, the tenants or the parking has to change for the number to move.
How income figures into pricing a commercial listing, as a seller's question rather than a definition, is the subject of selling commercial property in Southwest Virginia.
No published cap rate exists for these counties, so none is printed here
No public source gives a cap rate for Carroll, Grayson, Wythe, Pulaski, Montgomery or Floyd counties or the City of Galax, for any kind of property. This page prints no rate, no rent and no income figure, because any number here would be a guess dressed as a fact.
Even the local assessor's view of income is private. Va. Code 58.1-3294 lets a local real estate assessor require owners of income-producing real estate, with listed exceptions, to furnish income and expense statements for each parcel, certified by the owner or an authorized agent, and the section requires those statements to be kept confidential. How a given locality uses them in an assessment is a question for its commissioner of the revenue or assessor.
Where a lender needs a rate applied to a property, it comes inside an appraisal prepared by a licensed appraiser. A comparative market analysis works from what similar property sold for; income property adds the question of what its steady income supports, and the two readings do not always land in the same place.
An owner who wants a number before any of that can ask for an opinion of value from a real estate licensee, which is what the free valuation for land, homes and commercial property provides. It is an opinion, reasoned from the property and the record. It is not an appraisal and cannot stand in for one.
Want an opinion of value on income-producing commercial property?
Send the address, what the property is used for and whether it is leased or operating. Lowell can give an opinion of value and show the reasoning behind it. No cost, no obligation.
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Questions this raises
Is a higher cap rate better for the buyer or the seller?
Neither, in the abstract. For the same income, a higher rate produces a lower value and a lower rate produces a higher value, so a buyer and a seller will often argue for different rates. The OCC handbook says the rate should reflect the return investors and lenders require under normal, orderly and sustainable market conditions, which makes it a judgment about the return the income has to earn rather than a preference of either side.
Can a cap rate be applied to vacant land?
Usually not in any useful way. Direct capitalization divides a stabilized net operating income by the rate, and undeveloped land generally produces no income to divide. Land bought to build on is valued by other methods, including working backward from what the finished lots or pads would sell for, and a lender's appraiser chooses the method that fits the property.
Where this page's facts come from
Every rule, office and figure above traces to one of these. Rules change; check the office before you act on one.
- Comptroller's Handbook, Commercial Real Estate Lending, Version 2.0, March 2022 Office of the Comptroller of the Currency
- Va. Code 58.1-3294, income and expense statements from owners of income-producing real estate Code of Virginia