Capitalization Rate

A guideline that suggests a capitalization rate for the proposed loan. Usually lenders base this guideline on numerous factors including property type, loan amount, and numerous physical, financial and tenancy factors identified in the proposed loan. The cap rate is the rate of return on net operating income considered acceptable for an investor and used to determine the capitalized value. This rate should provide a return on, as well as a return of, capital; also known as “cap rate’. Also, the ratio of the annual NOl to the property price (or value). The formula is: Value = annual Income divided by the capitalization Rate (V=IIR). For example, if a property generates $100,000 of net operating income and the capitalization rate is 10.0%, then the capitalized value of the income stream is $1 000,000. Conversely, if a property generated $100,000 of net operating income and was sold for $1,000,000, then the sales cap rate is 10.0%. Cap rates are determined by various methods including market driven (derived from comparable sales), band of investment technique (mortgage- equity analysis), Ellwood formula, Akerson format, etc.