Investing is risky. However, with great risk and responsibility can also yield great rewards. As an investor, you know that it is not wise to only focus on profit. Protecting yourself against loss is equally important.
When considering investment into real estate, you should also educate yourself on capitalization rate.
Commercial Real Estate: Finding the Capitalization Rate
Chances are, you have heard of the term capitalization rate or “cap rate”.
This term is probably the most misunderstood concepts even though it is a very valuable and fundamental to real estate investment.
By using capitalization rates, you are able to actually track investment activity.
Cap rate is basically a formula. It calculates a property’s annual income and divides that by the cost or value. It is calculated and measured within a year’s time frame. It is also important to note that cap rate measures the property’s return for the year without considering the debt on it. This tool allows you to more easily track and compare values between properties.
Taking debt out of the equation allows for a more proper calculation of value between properties.
Basically, the cap rate shows you the calculations of the risk and what you should expect in return after everything is taken into account. Capitalization rate measures the risk on your investment. So, the higher the cap rate, the riskier the investment.
Determining whether or not your cap rate is “good” boils down to how you are utilizing it.
Commercial Real Estate: Capitalization Rate Factors
Cap rates can be affected by:
- Macro-level economics and demographics (the capitalization rate between markets)
- Micro-level market influences (comparing within a market)
- The type of property (for example, whether it is retail, residential, etc.)
It is important not only to research historical capitalization rates but also stay on top of current research. This will help you to steer towards valuation and a successful investment. Cap rate is a tool; it is there to help you make wise decisions for your investment, which in turn can lead to you reaching your goals.
A good capitalization rate will be different for each situation because of the different factors involved.
Real Estate Matrix is of the Southeast’s premier commercial valuation firms and has participated in the valuation of billions of dollars in real property assets.
If you have interest in having a business valuation performed you can contact Real Estate Matrix at (877) 453-0221 or click here to fill out our form and we will get back in touch with you as soon as we can.