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Step 1
Calculate the Capitalization Rate of a property by taking the net cash it is expected to produce and dividing it by the cost of the property. The resulting number when stated as a percentage is the Cap Rate.
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Step 2
Realize that the Capitalization Rate is far more complex than a simple formula. It assumes that the investment will be paid for in cash and that the income is consistent. If a loan is required to purchase the property then interest expense must be factored in. Income can fluctuate and there can be unexpected expenses like major repairs. These are all important factors that must be considered.
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Step 3
Understand how the Capitalization Rate is used. Investors often refer to the Cap Rate to determine how long an investment will take to pay for itself. If the Capitalization Rate is 10% then it should take 10 years. The Cap Rate is also a tool to help compare different commercial properties. A larger Capitalization Rate theoretically means a faster growing investment.
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Step 4
Remember that the Capitalization Rate is a ratio. An investor looks for property with a high Cap Rate since it will supposedly produce a high income relative to what they pay for it. A commercial property that produces vast income but is expensive would have a lower Capitalization Rate than one producing modest income but has a very low sales price. Cap Rate shows estimated return on an income property with no regard to the quality of the property.
