So many agents ask this question, and it is something you definitely want to know if you plan on selling commercial real estate. The capitalization rate is the rate of return on a property based on the income that the property is expected to generate. The capitalization rate is used to estimate the investor’s potential return on his or her investment.
The capitalization rate of an investment may be calculated by dividing the investment’s net operating income (NOI) by the current market value of the property, where NOI is the annual return on the property minus all operating costs. The formula for calculating the capitalization rate can be expressed in the following way:
Capitalization Rate = Net Operating Income / Current Market Value
Some consider the capitalization rate to be, in essence, the discount rate of a perpetuity, though the use of perpetuity in this case may be slightly misleading as it implies cash flows will be steady on an annual basis.
The capitalization rate is expressed as a percentage and is also often known as the “cap rate.”