Capitalization Rate – A ratio of net operating income to the value of an asset. For real estate investment, it is used as a valuation tool as a required return. Also called “cap rate”.
- Example: Investors determine their required capitalization rate and apply it to the expected net operating income of an investment property to determine what it is worth. If an investor is seeking to buy an investment at a cap rate of 8% and the expected annual net operating income is $100,000, the investor values the property at $1,250,000 ($100,000 ÷ 8% = $1,250,000).
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