Capitalization Rate

AAA

DEFINITION of 'Capitalization Rate'

A rate of return on a real estate investment property based on the expected income that the property will generate. Capitalization rate is used to estimate the investor's potential return on his or her investment. This is done by dividing the income the property will generate (after fixed costs and variable costs) by the total value of the property. If you want to get technical, it is basically the discount rate of a perpetuity.

Capitalization Rate = Yearly Income/Total Value

Also known as "cap rate".

INVESTOPEDIA EXPLAINS 'Capitalization Rate'

Capitalization rate is a good jumping-off point to quickly compare many investment opportunities, but it should not be the sole factor in any real estate investment decision. Many more factors need to be looked at such as the growth or decline of the potential income, the increase in value of the property, and any alternative investments available.

For example, if Stephane buys a property that will generate $125,000 per year and he pays $900,000 for it, the cap rate is: 125,000/900,000 = 13.89%.

But it gets a little more complicated. What if the property's value rises to $2 million two years later? Now the cap rate is a less favorable 125,000/2 million = 6.25%. This is because Stephane could potentially sell the property for $2 million and use that money for an alternative investment.

RELATED TERMS
  1. Overcapitalization

    When a company has issued more debt and equity than its assets ...
  2. Perpetuity

    A constant stream of identical cash flows with no end. The formula ...
  3. Present Value - PV

    The current worth of a future sum of money or stream of cash ...
  4. Capitalization Of Earnings

    A method of determining the value of an organization by calculating ...
  5. Capitalization

    1. In accounting, it is where costs to acquire an asset are included ...
  6. Dividend Discount Model - DDM

    A procedure for valuing the price of a stock by using predicted ...
Related Articles
  1. Personal Finance

    How Interest Rates Affect Property Values

    When interest rates fall, real estate prices tend to increase. Why? Find out here.
  2. Home & Auto

    Can Real Estate Stabilize Your Portfolio?

    History suggests that real estate can provide diversification and a hedge against inflation.
  3. Home & Auto

    Simple Ways To Invest In Real Estate

    Owning property isn't always easy, but there are plenty of perks. Find out how to buy in.
  4. Fundamental Analysis

    Taking Stock Of Discounted Cash Flow

    Learn how and why investors are using cash flow-based analysis to make judgments about company performance.
  5. Investing Basics

    The Most Popular Bitcoin Mining Software

    Success at mining bitcoins depends on the combination of time, knowledge, computer hardware and the complementary software.
  6. Mutual Funds & ETFs

    What is the difference between a hedge fund and a private equity fund?

    Learn the primary differences between hedge funds and private equity funds, both of which are utilized by high net worth investors.
  7. With stocks surging, financial advisers and their wealthy clients are asking why they should continue to bother with poorly performing alternatives.
    Professionals

    Are Advisors Off Alternatives?

    With stocks surging, financial advisers and their wealthy clients are asking why they should continue to bother with poorly performing alternatives.
  8. Mutual Funds & ETFs

    Where does a hedge fund get its money?

    Learn how a hedge fund is structured and how the managing partner of the fund goes about the process of finding and soliciting investors.
  9. Investing Basics

    What are essential steps to financial due diligence?

    Explore different areas of financial due diligence. Learn the steps of due diligence that may help ensure selected investments are profitable.
  10. Investing Basics

    Putting Your Retirement Eggs in Several Baskets

    When trying to reduce the volatility of one's investments, it's good to diversify by varying one's portfolio assets or doing some alternative investing.

You May Also Like

Hot Definitions
  1. Multinational Corporation - MNC

    A corporation that has its facilities and other assets in at least one country other than its home country. Such companies ...
  2. SWOT Analysis

    A tool that identifies the strengths, weaknesses, opportunities and threats of an organization. Specifically, SWOT is a basic, ...
  3. Simple Interest

    A quick method of calculating the interest charge on a loan. Simple interest is determined by multiplying the interest rate ...
  4. Special Administrative Region - SAR

    Unique geographical areas with a high degree of autonomy set up by the People's Republic of China. The Special Administrative ...
  5. Annual Percentage Rate - APR

    The annual rate that is charged for borrowing (or made by investing), expressed as a single percentage number that represents ...
  6. Free Carrier - FCA

    A trade term requiring the seller to deliver goods to a named airport, terminal, or other place where the carrier operates. ...
Trading Center