What is a Capitalization Rate?

The capitalization rate is also known as the reduction rate and the rate of return. It is also an interest rate like the bank rate. The latter is the ability to deposit money into a bank to generate interest, that is, the interest rate, while the former is the rate of return from capital invested in real estate. The two cannot be equivalent. Capitalization rates are also different from those in other industries because they reflect the profitability of different investment areas. Otherwise, wouldn't investment become too simple and simple? Everyone deposits money in the bank to earn interest and is both worry-free and safe. Theoretically, although market competitors tend to make the average annual profit margins of various industries consistent, the reality is not so simple. The application of new technologies, different investment portfolios, different investment areas and investment environments will generate new excess profits. Therefore, capitalization rates should not be confused with other interest rates (returns), although they may sometimes be equal or similar in quantity.

Capitalization rate

1. Real estates with different uses have different capitalization rates. Under the same conditions, the capitalization rates of commercial, office, residential, and industrial houses should be reduced in order.

2. Real estate investment risk is higher than

Risk compensation, tax exemption policy and

The principle of determining the capitalization rate

There are many opinions from domestic and foreign scholars in determining the capitalization rate. Here are some methods:

The capitalization rates are

The income method is based on the theory of the time value of money. To correctly understand the meaning of the rate of return on capital, we must first understand the time value of money. l1l. Because money has time value, the expected returns at various points in the future are not comparable. They must be converted to the same point in time to make quantitative comparisons. Investors in profitable real estate investments must choose an appropriate investment return. The rate is used as the discount rate, and the estimated time point for discounting the expected income at different points in the future. This discount rate is the capitalization rate of real estate investment.

Capitalization rate

The basic formula of the income method is:

V is the value of the real estate;

A 1, A 2 ... A n are the income of the following years;

r 1, r 2 ... r n are the capitalization rates for each year.

If it is assumed that the returns and capitalization rates in the subsequent periods are the same, in the case of a finite number of periods, the basic formula can be simplified to:

V is the value of the real estate;

A is the income of each period;

r is the capitalization rate.

When there are many years of real estate gains, it can be approximated that n is indefinite. At this time, the formula can be simplified to.

There are several methods to determine the capitalization rate:

(1) Market extraction method

This method is applicable to the situation where the real estate market is relatively mature, transactions are active, and market rents and transaction prices are relatively easy to collect. The method is easy to understand and has high accuracy, so it is widely used.

This method is a method of collecting the capitalization rate by collecting the price and income information of more than 4 real estates in the same real estate market and calculating it according to the calculation formula of the income method. which is

The specific method is to collect real estate data similar to the real estate to be evaluated from the market as a basis. In order to ensure the accuracy of the calculation, usually more than 4 similar transaction cases are selected, and the real estate transaction date is similar to the real estate to be evaluated. To be similar, then separately find the capitalization rate, and then take a simple arithmetic average or find a weighted average.

The application of this method is mainly due to the difficulty of data collection and the accuracy of the collected data may not be guaranteed. And for this method, many valuers in China believe that since there are comparable examples in the market, it is better to use the comparison method instead of the income method.

(2) Risk-free interest rate plus risk adjustment method

It is based on the theoretical basis: the investment must get a return, and the return is proportional to the risk. The higher the risk of the investment, the higher the return. If you do not want to take risks, you can only get a lower investment return. The formula for the capitalization rate under this method is: capitalization rate = safety interest rate + risk adjusted value.

Where r 1 represents the risk-free interest rate;

r 2 is the average rate of return required by the investment;

is the risk level of the investment.

For example: Assume that the average yield of the entire real estate investment market is 15%, and the rate of return of risk-free investments (usually replaced by the national debt rate) is 10%. The capitalization rate of real estate investment projects can be calculated.

r = 10% + 0.8 × (15% -10%) = 14%.

The difficulty in applying this method is that there is still no uniform standard for the determination of risk-adjusted values, and the value of different valuers will be different, which directly affects the valuation results.

(3) Compound investment income method

The premise of its use is to determine the mortgage interest rate of real estate financing, the return on investment of own funds and the proportion of their total value. The compound investment rate of return method is a method that uses the weighted average of the mortgage loan yield of real estate purchase and the return on own capital as the capitalization rate, and calculates it as follows:

.

In the formula, a is the ratio of mortgage loan to real estate value, r 1 is the interest rate of the mortgage loan, 1-a is the ratio of own funds, and r 2 is the return of own funds.

For example: a real estate investment, own funds accounted for 30%, mortgage loans accounted for 70%, the return rate of self-owned funds was 15%, and the interest rate of the mortgage loan was 10%, the capitalization rate of the investment can be calculated.

r = 70% × 10% + 30% × 15% = 11.5%

(4) Investment rate of return insertion method

This method requires finding out other types of investment related to real estate investment and their corresponding rates of return, and then making a comparative judgment based on their degree of risk to determine the capitalization rate of real estate investment. The basic idea of determining the rate of return on capital by the method of investment return order insertion is to first find out the various types of investment in the society related to real estate to be valued and their return rates, and then draw the curve of return rate versus investment type. Then, The investment in the real estate of the valuation object is compared with other investments to find the investment with the same risk, and the range of the capitalization rate should be judged to determine the required rate.

For example: the one-year deposit interest rate of the bank is 2.61%, the one-year government bond interest rate is 2.71%, the corporate bond yield is 5%, the one-year loan interest rate is 6.90%, and the investment stock yield is 8.2%. Consider investing in real estate The risk is greater than the one-year loan of the bank and lower than the investment stock, so its yield should be higher than the one-year loan interest rate and lower than the return of the investment stock, so it can be determined that the capitalization rate is between 6.90% -8.2%.

Capitalization rate = the interest expense of all special borrowings during the period / the sum of the product of the principal of all special borrowings and the time it takes

For example:

On January 1, 1996, two special loans were borrowed for the construction of a fixed asset, a sum of 1 million, which was repaid on July 1, with an annual interest rate of 6%, and a sum of 800,000, which was repaid on December 31, 1997. The annual interest rate is 10%. It is assumed that capitalization started on January 1.

Capitalization rate = (100 × 6% / 2 + 80 × 10% × 2) / (100/2 + 80 × 2) = 9.05%