The return on investment made in a real estate property. The rate of return is determined by dividing a property’s net operating income (NOI) by its current market value. This rate, expressed as a percentage, is an estimation for the potential return on a real estate investment. This rate is a key input in the calculation of the value of a real property (capitalization) whereby annual project income is divided by that rate. Capitalization is the worth (value) of a real estate property, applying the capitalization rate. Capitalization rate measures the performance of an investment in a property without taking into consideration any mortgage financing (funding costs).
Capitalization= annual income × capitalization rate
Capitalization rate, per se, is determined using the following formula:
Capitalization rate %= (NOI ÷ current MV) × 100
Current market value is the sales price of the property at the time of calculation.
The capitalization rate correlates “inversely” with risk: high-risk investments (in low-income areas) require low capitalization rates, while low-risk investments (in high-income areas) require high capitalization rates.
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