Examples of Capitalization Rate

capitalization rate

Calculating capitalization rate is very easy to do. If you see the previous explanation, then you will get the most popular and accurate definition of capitalization rate. Capitalization rate is ratio between NOI (Net Operating Income) to the current asset value of the property. You have to sum up all the expenses spent over one year to get the value of Net Operating Income.

In this part, we will give you several simple condition related to real estate property and also Then we will give you the brief calculation to apply the first formula in order to get capitalization rate. We are not using the second formula in this brief explanation since it doesn’t show the accurate value of the recent cap rate.

capitalization rate
capitalization rate

Not only that, you cannot apply the second formula to calculate capitalization rate to the inherited or gifted property. It is because the purchase price is zero since the property was gifted to them. Therefore it makes the distribution impossible to compute.

Capitalization Calculation

Now we can try to calculate the capitalization rate from the following example:

Suppose you have purchased a commercial property building at the price $ 2,000,000. While the value of NOI you get over one year is $ 200,000. Then, how much the cap rate would be? To calculate it you can use the formula stated above:

Capitalization Rate = Net Operating Income (NOI) / Value

Capitalization           = $ 200,000 / $ 2,000,000

Correct Rate             = 10%

It means that your property investment can give you 10 percent in return for one year ownership.

Then, how to get the value of Net Operating Income (NOI)? In this case, suppose you rent the building to some tenants which give you income per year $ 220,000. While you have to spent $ 20,000 towards several expenses such as property taxes and maintenance cost. Then it will give you net operating income at $ 200,000. In this example, we assume that the price of the property remains unchanged for one year.

capitalization rate
capitalization rate

Why capitalization value is very fundamental in the world of commercial real estate property?

This value is very important, for example when you research for the recent sale of an office building that classified as Class A building. If the office building has stabilized Net Operating Income (NOI) of $ 2,000,000 over a year and a purchase price at $ 20,000,000, then it is usual to say that this Class A office building is sold at 10% cap rate.

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