Next video:
Loading the player...

Capitalization Rate is a financial term most commonly used in the real estate investment industry. It is often simply called the Cap Rate.

The Cap Rate is the rate of return that an investment property will generate based on its current market value, and is a quick way to compare different investment property options including houses, apartments and office buildings.

To calculate the Cap Rate, divide the expected annual net profit on the property by the current market value of the property. Notice the cap rate uses current market value instead of original purchase value.

For example, an investor is considering buying one of 2 rental properties. Property A costs $1 million, and will generate $100,000 per year in net profit, after expenses. Property B costs $1.6 million and will generate $150,000 after expenses.

The Cap Rate for property A is $100,000 divided by $1 million, which equals 10%. This means the investor will earn 10% per year after expenses.

The Cap Rate for property B is $150,000 divided by $1.6 million, which equals 9.37%. This means the investor will earn 9.37% per year after expenses.

If the market value of Property A goes up 20% to $1.2 million, and the income stays the same, dividing $100,000 by $1.2 million shows the cap rate decreases from 10% to 8.3%. In other words, when market value goes up but income stays the same, the investor makes a lower cap rateThe opposite happens if the market value goes down but the yearly income stays the same. 

 

Related Articles
  1. Investing

    Learn to Value Real Estate Investment Property

    Make sure you know what your real estate investment is worth before you sign the ownership papers. Learn what capitalization rate means to your net operating income.
  2. Investing

    How interest rates affect property values

    Interest rates have profound impact on the value of income-producing real estate property. Find out how the rise and fall of interest rate affects property value.
  3. Taxes

    Sell Your Rental Property for a Profit

    Learn how to sell your rental property for a profit. Find out how to master the selling process.
  4. Investing

    4 ways to value a real estate property

    Here are several approaches to evaluate real estate properties for investment purposes.
  5. Investing

    Investing in Rental Property: What to Consider

    Investing in rental property has some unique issues which need to be considered.
  6. Investing

    Investing in out-of-state property

    If you can't afford property close to home, consider taking the real estate plunge elsewhere in the country, perhaps out of state.
  7. Investing

    How to Analyze Mid-Cap Stocks

    Mid-cap stocks often outperform both large caps and small caps with very little added risk.
  8. Managing Wealth

    Rental Properties: Cash Cow Or Money Pit?

    Create a real estate valuation system to forecast the profitability of an income-producing property.
  9. Taxes

    10 Things to Know About 1031 Exchanges

    Real estate swaps grow popular, but traps are many. Here's 10 things to know when considering 1031 swaps. Also: Beware new rules on vacation homes.
Trading Center