A capitalization rate is a way to convert income into asset value. It is calculated by comparing the cost of acquiring an asset to the amount of income it generates over a specific period. It can be used to project future earnings and can be affected by various factors.
A capitalization rate is essentially a rate that is used to convert income into some type of value that is realized in the asset. Perhaps the easiest way to think about a capitalization rate is to consider the relationship between the original cost of acquiring an asset compared to the amount of income the asset produces within a specific time frame. From this perspective, capitalization rates can be viewed as a proportion of the earnings associated with asset ownership.
Calculating a capitalization rate follows a very simple process. Essentially, all that is needed is to know the asset’s cost of capital, as well as the total amount of income generated by the asset within a given period of time. By calculating the relationship between the two figures, the capitalization rate of the asset is determined.
A capitalization rate can be calculated from the point of acquisition to the current date, or for any period in between. Some investors like to calculate the rate for specific financial periods, such as monthly or quarterly. Comparison of the results can indicate whether there has been a change in the capitalization rate from one period to the next, which can help the investor determine whether the asset is worth the effort to hold on to.
Understanding the capitalization rate in relation to normalized earnings can also help an investor project future earnings that can be anticipated from the asset. When undertaking future projects, the investor may also want to play around with a compounding discount rate, basing the figure on the rate calculated from different periods and using the average. As part of the process, the investor may want to take into account different factors that could affect the capitalization rate in future periods. Among these factors would be fluctuations in the stock market, changing economic conditions, changes in consumer preferences, and increased competition in the marketplace.
Smart Asset.
Protect your devices with Threat Protection by NordVPN
