What is a capitalization rate?
A capitalization rate can be defined as the percentage rate used to establish the current market value of a property. To complete the calculation, the capitalization rate is set against the Net Operating Income (NOI) of a property or asset. The value of similar properties in the market are compared and used to determine a capitalization rate.
Capitalization rate helps to forecast the Return on Investment (ROI) rate expected on an investment in a real estate property. It can be used to determine an estimate of the value or wealth an investor should expect from an asset or property. Thus, a cap rate is a great method of determining the profitability or loss of investment in a real estate property.
To calculate a capitalization rate and the current market value of the property first be established. A property’s current market value can be obtained by getting the selling prices of similar properties in the market within that period. Also, the Net Operating Income must be determined. Hence, when the Net Operating Income is divided by the current market value/cap of the property, the rate yielded will be the capitalization rate.
Capitalization rate is also known as cap rate.