Q:

# How Do You Calculate a Capitalization Rate?

A:

To find the capitalization rate, or cap rate, use the formula of capitalization rate equals annual net operating income over cost or value. The capitalization method is a different way of performing basic calculations in order to find the rate of interest that is used to calculate the current value of a property or value that will bring in income eventually.

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The following problem is an example of how to figure out the capitalization rate. Note that the multiplier decreases when the discount rate increases. A bookstore is anticipating returns of \$10,000 in the upcoming year. The discount rate is 8 percent. What would be the bookstore's worth?

1. First note that the discount rate given is 8 percent so the multiplier or capitalization rate is 12.5.
2. Multiply \$10,000 by 12.5.
4. If things were not as risky the discount rate might be 5 percent, so the multiplier would be 20.
5. Multiply \$10,000 times 20.
6. The answer would be \$200,000

Another capitalization method is called the stabilized cap rate which is where "Stabilized Year 1 NOI is possibly the average of all the years' NOI" over a period of detainment, such as 10 years. NOI stands for net operating income. Remember the cash flow is the only thing a capitalization rate recognizes.