I really don't want to get involved in this hot mess of an argument, but it looks like I've been dragged in so I'll clarify my position. I'll start by saying I'm far from the smartest person on this forum. :)
I agree with @Account Closed and @Jacob Sampson on this one, but can see where @Account Closed is coming from. Before everyone kills me, let me explain.
Capitalization Rate = NOI/Value (or Purchase Price), everyone on here agrees on that. So @Ethan Bruland is correct when he reasons that increasing NOI will increase the Capitalization Rate for this property. It is the calculation of Capitalization Rate for that particular property, independent of the prevailing capitalization rates in the area. There is definitely a distinction between the two, as @Account Closed and @Jacob Sampson pointed out. I agree with the information in their posts.
However, I'll try to find a middle ground and give @Account Closed the benefit of the doubt. He seems to be coming from a practical place. It seems to me he thinks that the only metric that is worthwhile - once you already own the building, that is - is the prevailing capitalization rate in the community rather than on the individual property. There is some merit to that. Having the "Cap Rate" of a building you own go up doesn't mean that much to me, it's the Value that makes the difference. One can "work backwards" to get a reasonable value for a property by using the prevailing Capitalization Rate for an area. (However, as noted above, there is definitely a distinction between the Capitalization Rate of a property and the prevailing Capitalization Rate for a geographical region.)
Correct me if I'm wrong, but I feel like that may be what @Account Closed was trying to express? If not, you're on your own. :)
At any rate, I look at it like this:
If Capitalization Rate = Net Operating Income/ Value, it follows that:
Value = Net Operating Income/ Capitalization Rate
@Ethan Bruland, if you know that investors in your area will generally deploy capital (invest money) at a 7% Capitalization Rate, for example, you're $19,000.00 NOI would make the theoretical Value $271,428.57. If you increase the NOI to $20,000.00, you would increase the theoretical Value to $285,714.29. Etc. I would tend to think about it in those terms rather than increasing the Capitalization Rate of a building that I own. It makes more sense to me to think of it in terms of overall Value of the property. I hope that makes sense.
You can look through similar recently-sold properties and calculate the prevailing Capitalization Rates in your area to get an idea for what to plug in as your anticipated Capitalization Rate for the purposes of the formula above. Investors in your area may also know off the top of their heads what the general rates are, but I would err toward calculating myself. It will also help you to assess whether or not the building you are thinking of buying is valued appropriately. What you are looking for is essentially an average of the Cap Rates, trying to eliminate any obvious outliers. Good luck!
