Capitalization Rate

Cap rate as it is referred to is the rate of return on a real estate investment property based on the expected income that the property will generate. A cap rate is used to estimate the investor’s potential return on his or her investment. This is done by dividing the income the property will generate (after fixed costs and variable costs) by the total value of the property.  R= the cap Rate,  I= yearly income and V= value. So if you know two of the variables you can solve for the third. For example:

 

R= I/V or  I/R=V or  Value times Rate = Income

If a property generates $150,000 per year (income) and the cost to obtain the property is 1,200,000 (value)then the cap rate is I/V=R   150000/1200000=.1250 or 12.5%

If you wanted an approximate value of the property you would use the same formula. 150,000 (income) divided by the desired rate of return 12.5%.                      150000/.1250=1,200,000

A cap rate is the simple basis to compare investments to each other. The actual process of evaluating potential investments is much more complex. Each investor has a different set of circumstances and tax strategies. The cap rate is a simple method to compare potential investments.

Category: For Sale