Cap Rates - Wicked Simple or Wicked Complicated?
Are cap rates wicked simple or wicked complicated? The snarky answer is “Yes.” What we mean is cap rates have an “everyday” application that is intuitive and simple. Its foundation, however, is much more complicated. As you move toward a career in a real estate private equity firm, you will need to learn to use cap rates in their simple form. But it never hurts to understand the origins of the concept. What is a Cap Rate? To begin, the term “cap rate” is shorthand for “capitalization rate.” The term is well-defined in real estate appraisals, and is aimed at determining a market rate of return for the property being appraised (see more on appraisals here ). The appraisal breaks the cap rate down into three component parts: the risk free rate, the equity rate, and the debt rate. The sum of these three rates becomes the capitalization rate used to arrive at the property value based on the income approach (specifically, net operating income divided by the cap rate equals the pr