Capitalization rate which is often referred to as “CAP RATE” is technically defined as the rate at which you discount future income to determine its present value.
So in practical terms CAP RATE is expressed as a ratio of an income-producing property’s value (V) and its operating income(NOI) for a current fiscal year.
“CAP RATE” for a particular property is mostly in line with other similar properties in that area and that would usually determine what the going price would be.
HOW TO CALCULATE CAP RATE.
Formular:
CAP RATE = NOI / V
Where the:
NOI is Net Operating Income
V is Value Of Property
Example:
Mr. Investor looked up an apartment for sale at a value (V) of $500,000, and Mr. Seller said the current Net Operating Income (NOI) of his property is $60,000, what would be the CAP RATE? …at which Mr. Investor would buy the property.
Apply formula:
CAP RATE = NOI / V
= 60,000 / 500,000
= 0.12 OR 12%
So the CAP RATE is expressed as a percentage. And you want to make sure you are always up to date with the prevailing “CAP RATE” for a particular income-producing property in the market that you desire to buy from. One of your best resources to get information like that would be brokers that list properties in that particular market.
When your CAP RATE increases the property price decreases and when you are buying at a lower CAP RATE expect the buying price to rise.
By Ola Ibiwoye BPHARM, RPH.
What is a good cap rate for real estate investment?
What is the difference between a cap rate and a gross rent multiplier (GRM)?
A cap rate and a gross rent multiplier (GRM) are both used to evaluate real estate investments, but they measure different aspects of the property’s value. The cap rate measures the rate of return on an investment based on its income, while the GRM measures the relationship between the property’s sale price and its rental income. The GRM is calculated by dividing the property’s sale price by its gross annual rental income.
Can the capitalization rate change over time?
Yes, the capitalization rate can change over time due to changes in market conditions, property performance, and investor demand. For example, if rental rates increase or expenses decrease, the property’s NOI would increase, resulting in a lower cap rate. Conversely, if rental rates decrease or expenses increase, the property’s NOI would decrease, resulting in a higher cap rate.
