# 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.
Collins Dictionary of Business, 3rd ed. © 2002, 2005 C Pass, B Lowes, A Pendleton, L Chadwick, D O’Reilly and M Afferson

## 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.

The Complete Real Estate Encyclopedia by Denise L. Evans, JD & O. William Evans, JD. Copyright © 2007 by The McGraw-Hill Companies, Inc.
References in periodicals archive ?
The real estate industry uses overall capitalization rates to measure investment activity for income producing real estate.
During the last decade, the mounting amount of capital poured into the market has continued to press down on capitalization rates. 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.
As interest rates begin to climb, Riggs believes that total returns could eventually increase, and capitalization rates could decline further to reflect income growth expectations.
The Appraisal Institute is also offering the one-day seminar, Supporting Capitalization Rates, nationwide.
The changes also limit capitalization rates and commissions charged by the administrators.
The data for the group of 40 were used to compute industry capitalization rates. Five different capitalization rates were determined: five-year, four-year, three-year, two-year, and one-year averages, each ending with the most recent year.
There are no safe harbor capitalization rates to assure a satisfactory valuation.
The excess earnings method values all of the permanent assets of the business, and the capitalization rates employed are for pre-tax returns of all of the permanent capital financing those assets.

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