capitalization rate

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Capitalization rate

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

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.

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.

capitalization rate

the rate at which the STOCK MARKET capitalizes the current earnings of a company. It is calculated by dividing a company's earnings per ordinary share by the current market price per ordinary share in order to arrive at the EARNINGS YIELD.

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.

References in periodicals archive ?
Appraisers who fail to consider the nature of federally regulated housing and the restrictions attendant thereto when deriving capitalization rates overlook major characteristics of such property.
The real estate industry uses overall capitalization rates to measure investment activity for income producing real estate.
Today, the tide is turning as capitalization rates begin their ascent.
Despite concerns about high energy costs, rising interest rates, and the possibility of higher capitalization rates down the road, investors have confidence about the future.
Toward the end of 2004, capitalization rates started to come down for independent living and assisted living, in particular.
First, capitalization rates started to come down for the best-run assisted living properties.
Cauley poses the question: Do these price increases, coupled with declines in capitalization rates, pose a bubble?
Participants work with realistic case studies to develop well-supported, market-extracted capitalization rates that reflect specific economic and property characteristics.
There are no safe harbor capitalization rates to assure a satisfactory valuation.
As noted earlier, the most problematic aspect of using an earnings-based model is determining the appropriate capitalization rates.
Capitalization rates are also heavily influenced by the current economic times as well as interest rates on available fixed income type securities.
Buyers may assign different Initial Year Market Capitalization Rates to different communities when determining the appropriate value because they (i) may project different rates of change in operating expenses, including capital expenditure estimates and (ii) may project different rates of change in future rental revenue due to different estimates for changes in rent and occupancy levels.