The implied cap rate turns a share price into the language of the property market, and three small choices in the build move it by more than half a point.
Take the market value of the equity, add debt, preferred stock and other liabilities, subtract cash and every asset that does not produce NOI, and divide forward cash NOI by the result. For an illustrative REIT at $28.00 a share the market is valuing the operating real estate at 8,330 ($ millions) against cash NOI of 560, an implied cap rate of 6.72 per cent. Against an illustrative private market rate of 5.75 per cent, that is 97 basis points of difference and a 20.1 per cent discount to NAV.
Worked in full in REIT Analysis and Valuation by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The implied cap rate is the share price translated into the language of the property market. It answers a simple question: if you bought every share and assumed every liability, what yield would you be paying for the buildings? Because it is computed on the same bridge as net asset value, run backwards, it is the cleanest way to compare a listed REIT with direct property, and the easiest to get wrong by a few dozen basis points.
| Input | Value |
|---|---|
| Shares outstanding, millions | 200 |
| Share price | $28.00 |
| Debt, at face value | 3,000 |
| Preferred stock | 200 |
| Other liabilities (payables, accruals) | 150 |
| Cash | 100 |
| Construction in progress and land, at cost | 400 |
| Other assets (receivables, prepaid) | 120 |
| Forward 12-month cash NOI of the operating portfolio | 560 |
| Straight-line rent included in GAAP NOI | 20 |
Implied real estate value = market cap + debt + preferred + other liabilities − cash − non-income assets
Implied cap rate = forward cash NOI ÷ implied real estate value
In Excel: =NOI/(Shares*Price+Debt+Pref+OtherLiab-Cash-CIP-OtherAssets). Keep the bridge in rows, identical to the NAV build, so that the two can be checked against each other.
| Line | $ m |
|---|---|
| Market capitalisation, 200 × $28.00 | 5,600 |
| + debt | 3,000 |
| + preferred stock | 200 |
| + other liabilities | 150 |
| − cash | −100 |
| − construction in progress and land | −400 |
| − other assets | −120 |
| Implied value of the operating real estate | 8,330 |
560 ÷ 8,330 = 6.72 per cent. The development pipeline and land come out of the value because they produce no NOI yet; leaving them in would divide this year's income by assets that will only earn it later. A more refined build marks them at an estimate of value rather than cost, but the principle is the same.
Run the same bridge forwards at an illustrative private market cap rate of 5.75 per cent. The operating portfolio is worth 560 ÷ 5.75% = 9,739; add cash, construction in progress and other assets, deduct debt, preferred and other liabilities, and the equity is 7,009, or $35.05 a share. The shares at $28.00 trade 20.1 per cent below it. The implied cap rate states the same gap in yield: 6.72 against 5.75 per cent, 97 basis points. Neither figure says which side is right, the public market or the appraisers, but the implied cap rate makes the question concrete: would a private buyer pay 6.72 per cent for these buildings?
| Share price | Implied value, $ m | Implied cap rate |
|---|---|---|
| $24.00 | 7,530 | 7.44% |
| $28.00 | 8,330 | 6.72% |
| $32.00 | 9,130 | 6.13% |
| $35.05, the NAV | 9,740 | 5.75% |
Each $1.00 on the share price moves the implied cap rate by about 16 basis points, and a 10 per cent fall in the price adds about 48. Leverage damps the move rather than amplifying it: the equity is only 67 per cent of the implied value, so a 10 per cent fall in the price is a fall of 6.7 per cent in the implied value of the buildings. Read the other way, that is the familiar point about REIT shares: a small change in what the buildings are worth is a larger change in the share price.
The forward NOI is where most of the judgement sits. Start from the most recent quarter's cash NOI annualised, add a full year of NOI for acquisitions closed during the quarter, remove NOI for properties sold, and add contractual rent steps and leases signed but not yet started. Leave out speculative lease-up of vacant space: the private market cap rate it is compared with is quoted on in-place income, and the comparison should be like for like.
The implied cap rate is forward cash NOI over the market's value of the operating real estate: 6.72 per cent here, against 5.75 per cent in the illustrative private market. Build it on the same bridge as the NAV and state the NOI basis. The complete analysis in the free workbooks for REIT Analysis and Valuation computes the two side by side, and the accretion article shows what a discount of this size does to a REIT's ability to grow.
They run the same bridge in opposite directions. NAV applies a private market cap rate to NOI and solves for the share value; the implied cap rate takes the share price and solves for the cap rate. In the illustrative case the price of $28.00 implies 6.72 per cent, and a 5.75 per cent private cap rate implies a NAV of $35.05.
Cash NOI, excluding straight-line rent and other non-cash items, because private market cap rates are quoted on cash income. Using GAAP NOI of 580 instead of cash NOI of 560 raises the illustrative implied cap rate from 6.72 to 6.96 per cent and makes the shares look cheaper than they are.
Less than the price itself, because the equity is only part of the implied value. In the illustrative REIT each $1.00 on the share price moves the implied cap rate by about 16 basis points, and a 10 per cent fall in the price raises it by about 48 basis points: equity is 67 per cent of the implied value, so the implied value of the buildings falls only 6.7 per cent.
This article is one calculation from REIT Analysis and Valuation. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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