What are CAP rates, net operating income and debt service coverage ratios?
CAP rate is a measure of the rate of return on an investment. It’s used to quickly compare profitability from one property to another. It is calculated as: Annual Net Operating Income (NOI) divided by purchase price or CAP Rate = NOI/Purchase Price. At the end of the day, the property is really worth the amount of cash it generates therefore, we can also say NOI/Cap Rate = Value. Net Operating Income is calculated as all revenue associated with the property less all expenses associated with the property. All expenses include: property taxes, insurance, maintenance, utilities, property management and miscellaneous expenses (it does not include interest expense or amortization of the debt). If some of the expenses are paid by the tenants, they of course are not included in the calculation. Debt Service Coverage Ratio is a gauge of the properties ability to pay back the loan from the cash it generates. It is calculated as Annual Net Operating Income divided by Annual Debt Service. Annual
