The capitalization rate, often referred to as the cap rate, is a key metric used in real estate and business valuation. It represents the expected rate of return on an investment property or business, calculated by dividing the net operating income (NOI) by the current market value or purchase price.

Characteristics
– Investment Indicator: The cap rate helps investors assess the potential return on an investment property or business.
– Risk Assessment: A higher cap rate typically indicates a higher perceived risk, while a lower cap rate suggests a more stable investment.
– Market Comparison: Investors use cap rates to compare similar properties or businesses in the market to determine relative value.
– Income Approach: The cap rate is a crucial component of the income approach to valuation, focusing on the income-generating potential of an asset.

Examples
– If a property generates a net operating income of $50,000 and is valued at $500,000, the cap rate would be calculated as follows: $50,000 ÷ $500,000 = 0.10 or 10%. This means the investor can expect a 10% return on their investment.
– A business that has a net income of $200,000 and is valued at $1,000,000 would have a cap rate of $200,000 ÷ $1,000,000 = 0.20 or 20%. This indicates a higher return, which may attract investors looking for higher-risk opportunities.