Question

1. What is the importance of the capitalization rate in real estate investing?   How and why is it utilized? Provide examples and elaborate on its usage. What is NOI and how is it utilized and for what purposes?

Answer 1

Capitalization rate = Net operating income / Market value of the asset (selling price)

Capitalization rate helps in evaluating the investments in real estate. It shows the potential rate of return on the real estate investments. Thus it helps the investors in comparing various investment opportunities in the real estate. A higher the capitalization rate is considered to be better for the investor.

• It also helps to form trends for commercial property owners to see where the market may head. It is suitable for the projects with regular cash flows.
• It serves as the first hand indicator of the investment worth. It guides the investors in buying and selling of projects.

Example : If the return of a financial security investment is 4% return and capitalization rate of a property is 8%, an investor may choose the property.

Net operating income is helpful for the investors to compute the Capitalization rate to analyse an investment in real estate. It is computed by deducting the operating expenses from the gross operating income of a project. The operating expenses are property taxes, maintenance costs, etc. (except depreciation)

• Net operating income (NOI) reflects the profitability of real estate investments.
• NOI is a good tool to find whether the income of a property covers its operating expenses or not.
• In the calculation of the net income multiplier, cash return on investment etc