Capitalization rate — How it influences the income value of a property
What is the capitalization rate? - The definition
The Capitalization rate shows the relationship between income and the value of a property. With the income value method, annual net rental income (gross income minus ancillary costs such as heating, electricity and water) is divided by an appropriate capitalization rate. The capitalization interest rate consists of the risk-free interest rate, a vacancy risk surcharge, administrative costs, retirement devaluation and the maintenance of the property. The reference interest rate for risk-free investments is, for example, the return on 10-year federal bonds.
The capitalization rate is an important key figure when valuing investment properties, i.e. properties that are primarily held for rental purposes. The higher the capitalization rate, the lower the estimated property value, as higher return requirements and risks are priced in.
How is the capitalization rate calculated?
The basic capitalization rate formula is:
- Capitalization rate = reference interest rate for risk-free investments + surcharges
As Reference interest rate The yield on 10-year government bonds is often used. Surges and reductions result from influences such as market and vacancy risk, maintenance and administrative costs, and inflation protection. Taking these components into account makes it possible to set the capitalization rate realistically and in line with the market.
The capitalization rate is calculated as follows:
- Risk-free interest rate (e.g. yield on 10-year federal bonds)
- Vacancy risk supplement (depending on the region, 1-4% vacancy should be assumed)
- administrative costs (usually around 4% of net rental income)
- Age devaluation of the building (approx. 1% per year; attention: Only the building is devalued, not the land)
- Maintenance depends very much on the age of the property (between 2 and 10% of net rental income)
The capitalization rate forms the basis for calculating the income value.
What is the capitalization rate for?
The capitalization rate is essential for valuing the income value of a property, which results from dividing the net rental income by the capitalization rate. The formula is:
- Income value = net rental income per year x 100/capitalization rate
Here, the net rental income is calculated by deducting operating costs such as electricity, water and heating from the gross rental income.
instance: An apartment building generates net rental income of 200,000 francs per year. CHF 200,000 with a capitalization rate of 4.5 percent results in the house's income value of CHF 4.44 million. If interest rates, vacancy risk or operating costs rise, the income value falls: With a capitalization rate of 5%, the income value of the property is only CHF 4 million.
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