What it means
Commercial property is priced on income, and the going-in cap rate, sometimes called the entry cap rate, is the shorthand the market uses for that price. It takes the net operating income the buyer expects in the first year of ownership and expresses it as a percentage of what the buyer is paying.
Net operating income, or NOI, is rental income after vacancy allowances and after property-level running costs such as management, insurance, repairs and property taxes. It is deliberately calculated before financing costs, depreciation and income tax, so that two buyers with different funding arrangements can compare the same building on the same basis.
The rate matters because it is the main negotiating language in property deals. Sellers quote a cap rate, buyers push back with a higher one, and a shift of a quarter of a percentage point can move the agreed price by millions on a large asset.
It also encodes risk and growth expectations. A prime office block let for fifteen years to a government tenant might trade at a low going-in cap rate because the income is dependable, while a half-empty industrial estate in a weak market needs a much higher rate to attract a buyer.
The obvious limitation is that it looks at a single year. Investors pair it with an exit cap rate, the assumed rate at which the building will be sold years later, and with a discounted cash flow model that captures rent reviews, refurbishment spending and lease expiries in between.
In practice
Real-world examples.
Example
A regional developer sells a newly built distribution warehouse let to a national grocer. The agreed price of $30,000,000 against first-year NOI of $1,650,000 implies a going-in cap rate of 5.5%, reflecting the tenant's strength and the long lease.
Example
A family office reviews two retail parades in the same town. One offers a 6% going-in cap rate with all units let, the other 9% with three vacant units, and the family office treats the gap as the market's price for the letting risk.
Example
A pension fund's investment committee rejects a deal because the going-in cap rate of 4.2% sits below the fund's cost of borrowing, meaning the purchase would be dilutive to income from day one unless rents grow quickly.
Think of it
“Going-in cap rate is your yield at purchase-initial income relative to price.
Formula
Calculation
Going-in cap rate = Year one net operating income / Purchase price
An investor is buying a suburban office park for $12,000,000. Gross potential rent for the first year is $1,400,000, from which a 5% vacancy and credit loss allowance of $70,000 is deducted, leaving effective gross income of $1,330,000. Operating expenses come to $490,000, so net operating income is $1,330,000 - $490,000 = $840,000. The going-in cap rate is therefore $840,000 / $12,000,000 = 7.0%. If a competing bidder offered $14,000,000 for the same income, that bidder would be buying at $840,000 / $14,000,000 = 6.0%, which is a more expensive purchase in yield terms.Case study
Seen in the real world.
Consider Millrace Property Partners, an illustrative and fictional mid-sized investor looking at a light industrial estate priced at $18,000,000. The vendor's marketing pack quotes a going-in cap rate of 7.2%, based on net operating income of $1,296,000.
Millrace's analysts rebuild the number. They find that two of the eight units are let at rents about 15% above the current market level, that the vendor has assumed only 2% vacancy against a local average nearer 8%, and that roof repairs of $400,000 have been treated as capital rather than as a recurring cost. On their own assumptions, first-year NOI is closer to $1,170,000, which at the asking price is a going-in cap rate of 6.5%.
Millrace bids $16,200,000 instead, which restores the 7.2% entry yield on its own income figure. The illustrative point is that the cap rate itself is never in dispute; the argument is always about the income number sitting on top of it.
Watch out
Common mistakes.
- Comparing cap rates from different sources without checking how NOI was defined. Some quoted figures deduct a management fee and a capital reserve, others do not, which can move the rate by half a percentage point.
- Reading a high going-in cap rate as automatically good value. High rates usually compensate for short leases, weak tenants, poor locations or looming capital spending.
- Confusing the going-in cap rate with the investor's actual return. The cap rate ignores debt, tax and any change in the building's value, all of which shape what the owner really earns.
Questions
People also ask.
Does the going-in cap rate include mortgage payments?
No, it is calculated before financing, which is what makes it comparable across buyers with different levels of debt.
How does it differ from the exit cap rate?
The going-in rate prices the purchase using year one income, while the exit cap rate is the assumed rate used to estimate the sale price at the end of the holding period.
Why do cap rates rise when interest rates rise?
Property competes with bonds for investor money, so when safer yields rise, buyers demand a higher income yield from property, which means paying less for the same rent.
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