Capitalization Rates
The Capitalization Rate or Cap Rate is a ratio used to estimate the value of income producing properties. Cap rates are rents relative to real estate value. While rents stay relatively stable, real estate prices fluctuate. As the demand for real estate increases, so do prices, causing cap rates to fall. The cap rate is net income divided by the value or sale price of a property, expressed as a percentage, the resulting figure reflects a return on and of capital.
The seller is trying to get the highest price for the property or sell at the lowest cap rate possible. The higher the selling price, the lower the cap rate.
The buyer is trying to purchase the property at the lowest price possible which translates into a higher cap rate. The lower the selling price the higher the cap rate.
Real estate valuation is a very complex business with many variables that affect price. Individuals who invest in real estate using income-producing properties should have a method to determine the value of the properties they're considering it is so critical to verify existing income and expense before establishing value.
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