Capitalization Rates

The capitalization rates are widely used by the income approaches of business valuation for the purpose of evaluating the business and to get an idea about the expected returns from that business. In other words, the capitalization rate is an evaluation regarding the yields produced by the assets.
This rate is mainly used by investors and the lenders to have an idea about the future buying price of various assets or properties. For the purpose of determining the capitalization rate for any property or asset, the assessors follow a certain process.

They collect data related to the similar type of deals in the recent times. These data are used in the capitalization rates to provide estimates regarding the selling price, rental and non-rental income and many more. The capitalization rates are different for the seller and the purchaser. Lower capitalization rates are preferred by the sellers as they denote higher price for selling the property.
On the other hand, the purchaser or the investor would be looking for higher capitalization rates because the cost of the asset of property would be low in that case.
The capitalization rates depend on a number of factors. The rates may be different for two neighboring areas. These rates are determined by factors like location of the property, availability of necessary amenities in a particular area, criminal activities in that area and many more. The trend is that the newly established areas are enjoying very low capitalization rates. At the same time, the old properties or properties in less convenient locations are not preferred highly by the real estate investors and so the capitalization rates are very high in these areas.

Capitalization rates generally use the in-place method or passing rent method to evaluate the properties. Along with the valuation calculated through the capitalization rates, another type of value is also provided to the prospective buyers, sellers or investors. This value is known as the estimated rental value and there is a difference between this value and value calculated through in-place method. This deviation is also termed as the reversionary value of the particular asset.

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Last Updated on : 27th June 2013

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