Capitalization Rate (Cap Rate)
The capitalization rate (Cap Rate) is the rate of return on a real estate investment based on its expected income.
The Cap Rate is calculated by dividing the property's Net Operating Income (NOI) by its current market value or purchase price. It represents the potential rate of return an investor can expect to receive on their investment if they purchased the property with cash and reflects the risk associated with the investment. A higher cap rate generally indicates a higher potential return but also a higher risk.
A property valued at $500,000 generates an NOI of $50,000. The cap rate is $50,000 / $500,000 = 0.10 or 10%.
Cap Rate is a percentage, so remember to convert decimals to percentages. A higher cap rate suggests a higher risk or a lower property value for the same income.
Related Terms
Practice Questions
Related Concepts
Net Operating Income (NOI) is the revenue a property generates after deducting all operating expenses.
In real estate, property value can be estimated by dividing the Net Operating Income (NOI) by the Capitalization Rate (Cap Rate).
IRV stands for Income, Rate, and Value. It represents the relationship between Net Operating Income (I), Capitalization Rate (R), and Property Value (V).
Proration is the process of dividing expenses or income between the buyer and seller at the closing of a real estate transaction. This ensures each party pays or receives only their fair share based on the period of ownership.
Daily rate calculation involves determining the cost or income per day by dividing the total amount by the number of days in the period (usually a year or a month). This is a fundamental step in proration.