What Is Capitalization Rate?
The capitalization rate (also known as cap rate) is used in the world of profitable real estate to indicate the rate of return that is expected to be generated on a real estate investment property. This measure is calculated based on the net income which the property is expected to make and is calculated by dividing net working income by property asset value and is expressed as a percentage. It is used to estimate the investor’s potential return on their venture in the real estate market. While the cap rate can be valuable for quickly comparing the relative value of similar real estate investments in the market, it should not be used as the only pointer of an investment’s asset because it does not take into account influence, the time cost of money and future cash flows from property improvements, among other factors. There are no clear choices for a good or bad cap rate, and they mostly depend on the context of the belongings and the market. Capitalization Rate Formula Some versions exist for the computation of the capitalization rate. In the thoroughgoing popular formula, the capitalization rate of a real land investment is calculated by dividing the property’s net operating income (NOI) by the current market value.
Mathematically, Capitalization Rate = Net Operating Revenue/ Present Market Value
The net operating income is the annual income generated by the property (like rentals) and is arrived at by deducting all the expenses incurred for managing the possessions. These expenses include the cost paid towards the regular upkeep of the facility as well as the property taxes. The current market value of the asset is the present-day value of the property as per the dominant market rates.