Capitalization Rate

Capitalization Rate

Capitalization rate, commonly known as cap rate, is a rate that helps in evaluating a real estate investment.

Definition: Capitalization rate, commonly known as cap rate, is a rate that helps in evaluating a real estate investment.

Cap rate = Net operating income / Current market value (Sales price) of the asset

Description: Capitalization rate shows the potential rate of return on the real estate investment. The higher the capitalization rate, the better it is for the investor. Net operating income, one of the metrics to compute the cap ratio, is found by deducting the operating expenses from the gross operating income.

The operating expenses can be property taxes, maintenance costs, etc. Operating expenses however does not include depreciation. Capitalization rate gives the first hand indicator of the investment worthiness of the asset. However, it is not an exhaustive measure by itself.

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