How Do You Calculate a Capitalization Rate?


Quick Answer

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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Full Answer

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.
  3. The answer is $125,000.
  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.

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