Calculating Capitialization Rates
(Cap Rates)
Estimating for income approach
1. Direct Capitalization
I=Net Income
V=Value
R=Rate
I= V x R
R= I/V
R=
NOI
or
NI
A. Sales Price
A. Sales Price
R= $50/Acre =10% Cap Rate
$500
2. Straight-line Capitalization
Cap Rate = “i” rate + Recapture rate
(recapture rate =1/remaining estimated life)
EX:
Assuming i=10% and R.E.L. = 20 years
Cap Rate = 10% + 1/20
Cap Rate = 10% (risk rate) + 5% (recap. rate)
Cap Rate = 15%
3. Summation Rate or “Built-up”
Cap Rate
Ex:
5.5%
2.0%
1.0%
.5%
9.0%
Safe rate of return on capital
Risk rate of return on capital
Non-liquidity rate
Management rate
“Cap Rate”
4. Band of Investment Approach
A.
Weighted average of various types of
capital
B.
Mortgage equity technique
Simple Weighted
Cost mortgage capital x % of capital
+
Cost of Equity capital x % of capital
A.
Example:
25% Down payment x 12%
(equity capital)
(equity yield)
75% Debt capital
(mortgage)
Cap Rate
=3%
+
x 10%
=7.5%
(Mortgage constant)
= 10.5%
B. Mortgage equity technique
EX:
Assumptions: 25 yrs amortized, 75%
mortgage @ 10% i rate, monthly
payments, 12% equity yield, 15%
appreciation, and 10 yr holding period
Note: Monthly payment coefficient, % loan paid in
time frame, and sinking fund amounts are
found in your charts
Calculations on next slide
+ Mortgage
coefficient
x % loan
=.1090 x 75% =.0818
+ Equity yield x % equity
=12% x 25%
=.0300
- Increase in
equity due
to principal
payments
= % loan x
=75% (.1544
x .05698)
=.0066
- Increase in
property
value
= % appr. x
S.F.
=15% x
.05698
=.0085
=.0967
= 9.7%
Cap Rate
(% loan paid
x sinking
fund)
5. Discounted Cash Flow or
Internal Rate of Return Technique
Estimate present value of the flow of
benefits and costs associated with an equity
investment to arrive at a rate of return.