Ownership & finance
Cap rate
Also written: capitalisation rate, capitalization rate
Cap rate, distinct from general real estate yield metrics, is the ratio of a hotel's Net Operating Income (NOI) to its current market value or purchase price. It measures an asset's unlevered, annualized return, reflecting the underlying operational risk and property valuation.
Formula
Cap Rate = Net Operating Income (NOI) / Property Purchase Price (or Market Value)
How it is used
Investors and lenders use cap rates to price hotel acquisitions, evaluate disposition timing, and benchmark asset performance against debt costs. A lower cap rate signals lower perceived risk or higher growth expectations, typically seen in prime urban or luxury resort markets. Conversely, higher cap rates apply to secondary markets or underperforming assets. Revenue managers and general managers influence this metric directly: driving RevPAR and controlling GOP expands NOI, which compresses the cap rate and increases overall asset valuation during refinancing or sale negotiations.
Worked example
A boutique hotel generates $1,800,000 in annual Net Operating Income after management fees and reserve funds. An investor purchases the property for $22,500,000. The cap rate is calculated as $1,800,000 / $22,500,000 = 0.08, or 8.0%. If the buyer increases NOI to $2,250,000, the property's value rises to $28,125,000 at the same cap rate.
Common mistake
Confusing trailing twelve-month NOI with stabilized forward-looking NOI, or omitting capital expense reserves, leads to inaccurate cap rate calculations and property misvaluations.