Rack-Rent

Rack-rent means charging the full rent a property could get on the open market. When the passing rent, the amount the tenant now pays, matches the estimated rental value, the property is said to be rack-rented. In that case the initial yield and the reversionary yield are the same, and the cap rate reflects the property's true income.

When passing rent is below market, the cap rate computed on it understates the property. A lease at $3,600 on a unit worth $4,000 shows a 5.0% cap rate on a $500,000 price where the rack-rented figure would be 5.8%. Buyers pay for that reversion, which is why below-market leases with near-term resets attract lower cap rates on passing rent.

When passing rent is above market, the opposite holds and the cap rate flatters the property until the lease resets. Appraisers handle this by computing NOI on market rent and adjusting for the lease; the UK yield tradition handles it by quoting initial and reversionary yields separately. Either way, ask whether the rent behind a cap rate is the rent the property will actually earn.

A rack-rent lease is a lease where the passing rent already equals the property's full market rental value, so the buyer inherits no built-in rent increase. Initial yield and reversionary yield match, which means the cap rate on that lease reflects income the property will keep earning.

A unit leased at $3,600 when rental value is $4,000 shows a 5.0% cap rate on a $500,000 price; rack-rented, the same unit shows 5.8%. When passing rent sits above market, the cap rate flatters the property until the lease resets, so always ask which rent sits behind the number.