Capitalization rates are used to determine the purchase value of commercial real estate by relating annual net operating income to purchase price. Understanding capitalization rates allows investors to evaluate whether a potential investment meets their criteria for return on investment. The rate is calculated through a mathematical equation and impacts both an property's estimated value and what a financial institution will offer as a maximum mortgage value.

1. Capitalization Rates: The Key to
Figuring Out Purchase Values

2. Understanding and interpreting capitalization
rates in commercial real estate are important for
an investor who is trying to determine the
purchase value of a building or business.

3. Investors have criteria they use to determine
where to invest their real estate dollars. Having
the tools to determine whether the investment
meets those specific criteria is essential to
successful real estate investing.

4. The capitalization rate is the
relationship between
the annual net operating
income and purchase price,
in a sales scenario. The rate
is determined using a
mathematical equation
that estimates the value
and rate of return on investment.
Financial institutions also use capitalization rates
when determining the maximum mortgage value
for a specific investment.

5. The value of a property is determined by dividing
the net operating income by the rate at which you
expect a return on your investment. For example, if
a business has a net operating income of $25,000
and expects an annual return on investment of 10%
of the value, then the business’s value should not
exceed $250,000. Based on this scenario, the initial
investment value would be recouped in 10 years if
no additional expenses were incurred during that
period.

6. Real estate and mortgage
professionals use a
variety of formulas to
calculate capitalization
rates for specific
investments. The example
above is only one method that can be used to
compare values to a specific investment criteria.
You can tailor your search to meet your business
needs by discussing your investment expectations
with your real estate professional.

7. Randy Bett
www.BetterGroupRealEstate.ca