Capitalization rate, abbreviated as CR, as also called cap rate, is used in real estate to evaluate the potential return on an investment property. It's essentially the rate of return that an investor can expect to receive on their investment in the property.
breakdown of terms
- Net Operating Income (NOI) - This is the total income generated by the property from all sources, including rent and any additional revenue, minus all operating expenses such as property taxes, insurance, maintenance, utilities, and property management fees. NOI excludes financing costs like mortgage payments or interest expenses.
- Current Market Value or Purchase Price: - This represents the current value of the property in the market or the price at which the property was purchased.
The capitalization rate helps investors compare different investment opportunities and assess the risk associated with a particular property. A higher cap rate generally indicates a higher potential return but may also imply higher risk or lower property value. Conversely, a lower cap rate suggests lower risk but may yield a lower return on investment.
Investors often consider factors such as location, property type, market conditions, and potential for future income growth when analyzing cap rates. It's important to note that the capitalization rate is just one of many factors to consider when evaluating an investment property and should be used in conjunction with other financial metrics and qualitative considerations.
Capitalization Rate Formula |
| \( CR = NOI \;/\; CMV \) |
| Symbol |
| \( CR \) = capitalization rate |
| \( CMV \) = current market value of the property |
| \( NOI \) = net operating income |
