capitalization rate

Capitalization Rate

According to the Appraisal Institute, it is a method used to convert an estimate of a single year's income expectancy into an indication of value in one direct step, by dividing the income estimate by an appropriate rate.

Notes:

Also known as the cap rate. The relationship between Cap Rate (R), Income (I), and Estimated Value (V) is as follows:

V = I / R
I = V x R
R = I / V

See also: Capitalization, Interest Rate, Overcapitalization, Present Value

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Capitalization rate

The interest rate used to calculate the present value of a number of future payments.

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capitalization rate

The rate used to convert an income stream into a present value lump sum. For example, a capitalization rate of 10% and an income stream of $2,000 annually provide a present value of ^$2,000/_0.1 , or $20,000. The capitalization rate for a particular flow of income is a function of the rate of interest on Treasury bills (the risk-free rate) and the risk associated with the flow of income. A riskier investment has a higher capitalization rate and, therefore, a lower present value.