capitalization rate

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.

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Capitalization Rate

The net income an asset produces in a given year divided by its purchase price. The capitalization rate is used to help determine the rate of return, or how fast an asset pays for itself and begins to make a profit. For example, if an asset cost $1,000,000 and it produces $100,000 in a given year, the capitalization rate is 10% and it will take 10 years to pay for the asset with the money it produces. However, it is important to note that the capitalization rate may change from year to year. For example, the same asset could produce $100,000 in year one but $250,000 in year two. It is informally known as the cap rate.

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capitalization rate

Usually called a cap rate,it is a number used in order to estimate the value of an income-producing property.There are no cap rate tables,no firm standards,and no universal formulas for arriving at one.Cap rates change frequently,depending on market demand for particular types of properties, lender appetite for particular types of loans, and prevailing interest rates. Most commercial real estate brokers,appraisers,and lenders know a range of cap rates for different types of properties.One divides the annual net operating income by the cap rate to arrive at a value.Highquality multi-tenant medical offices might sell for cap rates of 7 percent, and rundown apartment buildings with high turnover might sell for a cap rate of 13 percent.If both of them had gross rents of $300,000 per year with operating expenses of $60,000, then each would have a net operating income (NOI) of $240,000. By dividing the cap rate into the NOI, the medical offices would have a value of $240,000 0.07, or $3,428,571.Using the same formula for the apartments,but the higher cap rate, $240,000 0.13 gives a value of $1,846,153. It seems counterintuitive at first, but the higher the cap rate,the lower the value.