Denominator of cap rate

[Mark Forest]

I know that the numerator of cap rate is the net operating income.  However, I seem to see confusion on what is included on the denominator.  Is it the entire purchase price of the property including any amount financed plus closing costs plus what you estimate it will be to renovate the property?  

Thank you to all who have a clear answer.

[Roy N.]

@Mark Forest 

The thing about CAP rates is they are easily and frequently misused.

CAP rates are only useful to compare the cost of cash-flows in a local market, and then only if each CAP is calculated using the same method {you and I could calculate the CAP for a given building and get different results}. Finally the CAP does not tell you anything about the quality of a cash-flow, just its cost relative to its peers.

So if you had a 100-unit property in Manhattan with a CAP of 5% in might be delightful, but one in Toledo with a CAP of 5% probably is not .... furthermore, using CAP to compare these two properties is dangerously meaningless.

Similarly, CAP would not be a useful metric to compare a quadraplex with a 50-unit apartment as the nature (quality) of the cash-flows would be substantially different.