What is a cap?
A cap – also known as capitalization – is a procedure that uses a percentage rate to convert an asset’s net operating income into a value estimate. This means that a cap determines the worth of an asset-based on the net income generated by that asset for a specific period.
In real estate, brokers or other professionals use the capitalization approach to establish the value of the property. The property is usually regarded as an investment property for the purpose of generating an operating income. The value of the property is then set against a percentage rate (otherwise known as the capitalization rate) for onward conversion to establish the cap. The question is how these rates or values can be determined.
The income generated by a property is easily ascertainable from records. The selling price or value of the property can be determined by the current market value of similar properties. The percentage rate is also established by the market based on the values of similar properties. With these figures, the capitalization of the property or asset can be determined.
A cap is used in real estate niche to determine the value of investment to be infused into a property to get the desired income.