Last month, we described the calculation of Capitalization Rate in this post. There is however more usual use of the cap rates. In this case, when the cap rate of similar properties in a certain area is a known parameter, we can reasonably estimate the property value based on this cap rate. Again NOI has to be constant in time.
This value estimation based on cap rate is quite widely used. However there are a few important setbacks which have to be known to each investor, before using this ratio. First, it is important to find very accurate information about cap rates in the local market area. For the USA market realtyrates.com can be used as a valuable source for this type of data. Other factors have to be considered as well, such as changes occuring to the local area and the fact that this calculation does not reflect adjustments in value for necessary capital improvements or expected vacancy losses.