In this essay, we will discuss ‘Capitalization rate’, ‘cap rate’. I will define it in financial terms and provide you an example in figures. Further, we will delineate the importance of Cap rate and how you can implement it today! Cap rate is a percentage in Real Estate to value the expected rate of return will be on a real estate investment property.
The capitalization rate is a relationship between the annual net operating income (NOI) and the price of the property. Cap rate = Net operating income / price of the property. The NOI is the income that remains after all operating expenses, insurances and taxes are paid. If annual NOI is $50,000 abd the price of the property is $1,000,000 then the Cap Rate is 50%.
A rule of thumb is that a lower cap rate implies a higher price and a higher cap rate implies a lower price. For example, an investor may expect to pay $100,000 for a real estate property with an NOI of $50,000 and a Cap Rate of 50%, 50,0000 / .5 = 100,000.
You don’t want to buy a risky property. That is a property that may not deliver steady returns in the future. Just as stocks offer higher returns than bonds for their risk, similarly a cap rate should be decided in favor of the investor’s needs.
Cap rate is a relationship between the net operating expenses and the price of a property. Generally, a higher cap rate means lower price, and vice versa. You don’t want a low cap rate for a very risky asset. Do your homework and take into account annual net operating incomes along with the price your getting for the property.