What is Cap Rate?

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What is Cap Rate?
Cap rate or capitalization rate is a ratio referring to the value of a particularly property based on its operating income and capital cost or market value. It is used by appraisers, lenders, and investors to have an estimate value of a property that is said to be income-generating.

In simple terms, the capital rate of a particular property may be computed by taking its net operating income for the year and divide this with the property’s original cost. In other computations, the current market value of the property may be used instead of its original or capital cost. So if a property is acquired at 2 million dollars and has a 200,000 dollar net operating income, its capitalization rate would be 10 percent.

But for other appraisers and lenders, capitalization rate is best computed using the property’s current market value as this represents a more realistic estimate of the property’s value. For would-be investors, they would want to know how quick their investments would return money. Many of them prefer quotations that are based on recent market values. Using the example given in the previous paragraph, if the actual property value has depreciated to 1.5 million, the cap rate will now go up to 13.33 percent. The lower the selling value of the property, the higher the cap rate will become. In this context, sellers will prefer lower cap rates to sell the property at a higher price, while buyers or investors would want a higher cap rate, as this represents lower selling price for the property involved.

Before anybody decides to purchase some property, he/she must consult with trusted appraisers. It is also important to know on how cap rates were computed for specific properties. Having all the necessary information is essential in the decision-making process of acquiring or buying properties. After all, everybody wants a speedy return for any investment.

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