Cap Rate (short for “Capitalization Rate”) is the profit generation percentage of a particular real estate property. It is determined by dividing the net revenue generated from the real estate asset by the present market value of the asset. The formula is given below -
Cap Rate = (Net Operating Income / Market Value) x 100
(Here, the Net Operating Income or NOI can be determined by subtracting the operating cost from the revenue out of the income-generating real estate.)
The capitalization rate is calculated to determine the potential return of the investment on the real estate property. A high cap rate would make the property more lucrative to invest in for the buyer.
For example, if the net operating income of somebody’s vacation home in the Maldives is $40000 and its current market value is $300000, the capitalization rate would amount to:
($40000 / $300000) x 100
= 0.1333 x 100
= 13.33%
So, it means if the property is sold at present, it will be sold at a 13.33% cap rate. This rate is usually calculated for real estate assets only and it is always expressed in percentage.
Use of the Term in Sentences
- It is always a good idea to look for properties with a high cap rate before investing in them.
- If there is a low cap rate, the property should always come with a low price tag.