The overall capitalization rate, or simply the capitalization rate or cap rate, is the reverse of the Net Income Multiplier (NIM). It is actually an income return measure and denotes the percent of the value represented by the property’s Net Operating Income at the time of purchase.
Capitalization Rate = Net Operating Income (NOI) / Market Price (5)
Given formula (5), it is obvious that this measure is applicable only to properties that produce income, that is commercial properties that are rented as opposed to owner occupied, and apartment buildings.
EXAMPLE
Market Price = $1,000,000
NOI = $100,000
Capitalization Rate = 100,000/1,000,000 = 0.10 or 10%
In this example, the capitalization rate indicates that the property would provide at the time of the purchase a 10% income return given the seller’s asking price.
This is an excerpt from the e-book Real Estate Investment Mathematics.
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Return from Overall Capitalization Rate to Investment Analysis
