Motel Capitalisation Rates Explained

A capitalisation rate — cap rate — is the yield a buyer requires on their purchase. In simple terms: value equals Adjusted Net Profit divided by the cap rate. A motel earning $500,000 in sustainable profit at a 10% cap rate indicates a value of $5,000,000. The same profit at an 8% cap rate indicates $6,250,000.

Note the direction: lower cap rates produce higher values. This confuses many first-time sellers, because everything else in business feels like 'higher is better'. In yield terms, lower means the buyer is paying more for the same income.

Cap rates reflect perceived risk and alternatives. A well-located, well-maintained freehold motel with consistent profit in a town with a diversified economy will attract a lower cap rate than a tired property with volatile earnings in a single-industry town.

Interest rates matter too: as borrowing costs rise, buyers require higher yields, which pushes cap rates up and values down. Cap rates are ultimately set by the market — by what real buyers will genuinely pay for real income streams.

Cap rates are the standard language for freehold going concerns because real property is included. Leaseholds — business only, no land — are more commonly discussed in profit multiples, where the relationship runs the other way: a higher multiple means a higher value.

They're two ways of expressing the same idea: what a dollar of motel profit is worth to a buyer, given the risk of receiving it.