What is Going-In Cap Rate?
The Going-In Cap Rate in real estate is the ratio between a property’s stabilized net operating income (NOI) and the project cost, expressed as a percentage.
How to Calculate Going-In Cap Rate
The “going-in” cap rate is a real estate investing metric wherein the traditional capitalization rate is modified to measure the yield as of the date of property stabilization.
The capitalization rate, or “cap rate” for short, estimates the implied yield earned on an income-generating property investment.
In particular, the use-case of the going-in cap rate is intended for development projects, which involve a period of construction work when there are no tenants (and thus no income).
Once the construction of the property is complete and rental leases are signed with tenants – i.e. the investment property is now fully operational – the property is deemed “stabilized”.
In real estate investing, development projects differ from property acquisitions because in the latter investment type, the acquired property generates cash flow starting immediately from the initial purchase date.
The going-in cap rate is calculated by dividing the stabilized net operating income (NOI) of the property by its total purchase price.
- Stabilized NOI → The pro forma net operating income (NOI) of a property once a state of normalization is reached.
- Total Purchase Price → The total costs incurred by the real estate investors as part of undertaking the property development or acquisition project.
The stabilized net operating income (NOI) is often annualized by multiplying the NOI of the most recent month and multiplying it by 12 or by multiplying the pro forma forward three months NOI and multiplying by 4.
Other adjustments to further normalize the net operating income (NOI) for external factors such as seasonality can also be necessary.
Under the context of a development project – contrary to an acquisition project – the total cost component includes the following:
- Land Purchase Price
- Construction Costs
- Transaction Advisory and Legal Fees (3rd Party Professional Fees)
- Financing Fees (e.g. Origination Fee)
On the other hand, the total purchase cost is simply the denominator for acquisition projects.
Going-In Cap Rate Formula
The going-in cap rate formula is as follows.
The output will be in decimal format, so it is necessary to then multiply the resulting figure by 100 to convert the going-in cap rate into a percentage.
