Capitalization Rate
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Capitalization Rate
Description:
Commonly referred to as the "cap rate". It is ratio used by real estate investors to help estabilish the value of an income producing property. To find the capitalization rate, divide the sales price of the building by the yearly net operating income. A $1,000,000 with NOI of $50,000 would have a cap rate of 5%.
In general the cap rate is used in reverse to estimate the value of real estate based off the type of property. For example, higher quality, multi-tenant buildings might generally have a cap rate of 6-7%, whereas lower quality buildings with high tenant turnover may have cap rates of 9-10%.
To estimate the value of a property, a potential buyer would divide the yearly net operating income (NOI) by the cap rate to arrive at an estimate. For example, a building type that generally has a 10% cap rate, with a NOI of $200,000 per year, would be estimated to be worth $2,000,000.
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