Real estate investors use various indicators in their own activities. This applies to the valuation of objects that generate income. For example, the location of the facility or any upcoming changes in the area may be of interest. The capitalization rate is one of the most important indicators that has a direct impact on decision-making in real estate. Using it, investors compare different objects, making an assessment of potential profit.
Definition
What is a capitalization rate? This ratio is the ratio of the purchase price of the object and net profit. By calculating this, investors calculate the ratio of the market value of the object and the net income that it brings during the year.
As a result of these calculations, it is possible to find out the percentage of income that can be obtained by acquiring an asset. It is worth noting that the capitalization rate is a rather controversial indicator for Russian realities. It is far from always possible to accurately calculate it. This is due to the lack of statistical information on the real estate market.
Application
The capitalization rate is an indicator that is used to bring income streams to a single value. In economics, this ratio provides information on the rate of return that the investor will receive, taking into account some risks, as well as possible changes in the value of the object.
In Russia, this method of calculation is rarely used. This is due to the fact that reliable information can be obtained only if the evaluated object (for example, an enterprise) brings stable income.
What is it for?
So, you know what a capitalization rate is. However, this is not all you need to know. The above ratio allows you to quickly compare investment opportunities. Usually it is expressed as the percentage profit that the investor promises to purchase real estate. That is why this indicator is ideal for comparing several similar investment options. Using the capitalization rate, you can quickly compare the level of potential income and in this way reduce the number of relevant options.
The capitalization rate allows you to determine the level of income. If you know this ratio in any area, it will not be difficult to calculate the net profit that will need to be received for the return on investment. It is enough to multiply the value of the object and the capitalization rate. This will reveal the approximate level of rental rates, below which the potential owner should not lower the bar. Using this method of calculation, you can decide on the feasibility of the transaction
It's important to know
Experts do not recommend taking into account the capitalization rate as the only factor of investment viability. This indicator makes the comparison more convenient. However, you need to understand that real estate investment is a rather complex area that requires a more detailed approach. Even simpler investments are dependent on market and unforeseen circumstances.
Before purchasing, you need to make sure that investment property will generate income. It is also important to calculate the possible costs, changes in the value of the object and other factors that affect the situation.
The risks
You need to understand that the capitalization rate does not reflect the likelihood of any risks. Do not take this ratio as a guarantee that the value of income or the current level of income will remain unchanged throughout the entire period of time. Both rents and property prices may increase or, conversely, decrease. According to experts, the capitalization rate does not carry information about such changes. That is why the calculations must be more subtle. A potential investor should consider as much of the available information as possible.
Features of the calculation
Assume that the capitalization rate will be used to assess the investment attractiveness of a property:
- First of all, you need to calculate the annual income. As a rule, this is the profit that the rental brings. However, this is not the only potential source of income. That is why for more accurate calculations you need to collect detailed information about the property.
- Any object brings to its owner not only income, but also expenses. They are also important to consider. This, as a rule, is the cost of insurance, taxes, maintenance of the object, etc. They must be deducted from annual income. In this way, the so-called net profit is calculated. An important nuance is that in these calculations, the costs of include the costs of acquiring real estate, as well as the payment of interest on the loan. Otherwise, the calculations will be incorrect.
- Now it remains to use the formula, according to which to determine the capitalization rate it is necessary to divide the net profit by the value of the property.
Examples
Let's try to calculate the capitalization rate for the property:
- If the rental price is a conditional thousand rubles, then for a year a potential investor can earn twelve thousand rubles in this way.
- Next, we deduct the costs that the content of the property carries. If they amount to two thousand rubles, then the net profit will be ten thousand rubles.
- If we assume that a potential investor purchased the object for a conditional two hundred thousand rubles, then the capitalization rate in our example will be twenty percent.
Agree, the calculations are quite quick and relatively simple. For this reason, this coefficient is convenient to use for quick comparison of several options.
Interest rate with capitalization
This term also needs some explanation. First of all, we inform that this concept is relevant in the banking sector. For example, when opening a deposit.
Capitalization of the deposit involves the addition of interest to the initial amount of the deposit. In the future, this leads to more profit. Even if the bank offers a standard rate on deposits with capitalization, as a result, the client manages to get a higher return. This is due to the fact that interest will be charged on a large amount. It includes not only the initial amount of the contribution, but also accrued.
It is worth noting that many banks offer deposits at which rates with interest capitalization apply. Therefore, it will not be difficult to find such offers and in such an absolutely uncomplicated way to increase equity.
It is very important to take into account the fact that interest on a deposit should be calculated every day. However, capitalization is calculated depending on the conditions specified in the agreement concluded between the bank and the client.
That is why you need to pay special attention to this item. The more often capitalization occurs, that is, the addition of accrued interest to the total amount of the deposit, the faster your income on the deposit increases. However, Russian banks do not offer their own customers daily capitalization. As a rule, at best, this process is performed monthly. Under the terms of some lending institutions, capitalization is even less common. For this reason, customers may receive less revenue. That is why it is so important to be knowledgeable regarding the terms of the contract.
If an annual rate with capitalization is indicated, it will usually be higher than for other offers. That is why such contributions can be determined, even if you do not read the conditions. To calculate the potential income, you can use specialized calculators on the website of banks or third-party services. It’s better to count several times to get accurate results.