Investors use a property’s capitalization rate to determine its potential as a profitable investment. Capitalization rates–often referred to as cap prices –vary by neighborhood and property type. Investors favor higher capitalization rates to lower ones, but may choose a property with a lower rate of returns if it’s less perceived danger. They are also subject to changing marketplace conditions. While capitalization rates aren’t an investor’s only tool for valuing commercial real estate, they do provide an objective measure of investment possible if comparing properties.
Determine the property’s gross earnings by totaling rents along with some additional income produced by the property.
Subtract any money lost because of deductions from gross earnings to locate the effective gross earnings.
Subtract operating expenses, such as leasing, management and maintenance charges, from effective gross earnings to come across net operating income.
Divide net operating income by the home’s sales price to come across the capitalization rate. As an example, assuming net operating income of $50,000 plus a sales price of $650,000 yields a capitalization rate of 8 percent.