Assume an investor is considering buying into a parking lot that is expected to generate $500,000 in net operating income. The advantage with the market-extraction method is that the capitalization rate makes the direct income capitalization more meaningful.ĭetermining the capitalization rate is relatively simple here. This method assumes that there is current, readily available net operating income and sale price information on comparable income-generating properties.
There are several methods that investors can use to find an appropriate capitalization rate. The $7,142,857 market value represents a good deal if the property is selling at $6.5 million and it would be a bad deal if the sale price is $8 million.ĭetermining the capitalization rate is one of the key metrics in valuing an income-generating property. Put simply, it is the rate that is applied to net operating income, to determine the present value of a property.įor example, if a property that is expected to generate net operating income (NOI) of $1 million over the next 10 years is discounted at a capitalization rate of 14%, the market value of the property would be determined to be $7,142,857 ( market value = net operating income / capitalization rate = $1,000,000 /. One of the most important assumptions that a real estate investor must make when valuing properties is choosing an appropriate capitalization rate, which is the required rate of return on real estate, net of value appreciation or depreciation. Investing in income-generating real estate involves market data and a degree of subjectivity.
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