Market capitalisation rate

Market capitalisation rate

The market capitalisation rate is the total dollar market value of outstanding shares of stock of a company. Instead of sales or total assets, the investment community uses this metric to assess a company’s size. The market cap is used to analyze whether a takeover candidate delivers value to the acquirer. 

In commercial real estate, the projected rate of return on an investment property is referred to as the market capitalisation rate. This metric is calculated based on the property’s expected net income and is expressed as a percentage by dividing net operating income by property asset value. It calculates the possible return on an investor’s real estate investment. 

What is market capitalisation rate?

The market capitalisation rate is a real estate valuation metric used to compare various real estate investments. Even though there are numerous variants, the cap rate is often calculated as the division of the annual rental income of a real estate asset by its current market value. 

The definition of annual rental income determines the majority of variations and whether it is gross or net of annual costs, as well as whether the annual rental income is the actual amount received (initial yields) or the potential rental income that could be received if the asset is optimally rented. 

The market capitalisation rate is most useful for comparing the relative value of comparable real estate investments. 

Understanding market capitalisation rate 

The market capitalisation rate is the most commonly used metric for evaluating real estate investments’ profitability and return potential. The cap rate shows the return over one year if a property is bought in cash without a loan. The capitalisation rate represents the intrinsic, natural, and unlevered rate of return on the property. 

The capitalisation rate is a profitability indicator used to calculate a real estate property’s return on investment. It is determined as net operating income divided by the asset’s current market value. 

The capitalisation rate can be used to determine how risky an investment opportunity is; a high capitalisation rate denotes higher risk, while a low capitalisation rate denotes lower risk. However, the capitalisation rate should always be used following other metrics rather than as the sole criterion for an investor to purchase a property. 

How to calculate the market capitalisation rate? 

The market capitalisation rate of a real estate investment is determined using the most general formula by dividing the net operating income (NOI) by the property’s current market value. 

Market Capitalisation Rate = Total Operating Income / Current Market Value. 

After subtracting all expenses associated with property management, the (anticipated) annual revenue generated by the property (such as rents) is known as the net operating income. 

Importance of market capitalisation rate 

The market capitalisation rate is crucial because it allows potential investors to grasp the true value of firms, and the relative size of one company to another. It assists investors in predicting the future performance of a company’s stock since it indicates what the market is prepared to pay for the stock. 

With a better understanding of the market capitalisations of various companies, investors can make more informed decisions about the types of stocks they want in their portfolios based on their investment goals. Large-cap, mid-cap, and small-cap stocks have the potential to lead the markets over time because they are affected differently by economic changes. As a result, investors prefer to have a diverse portfolio that includes a well-balanced mix of these three types of stocks. 

Types of companies based on market capitalisation rate 

People frequently categorize corporations based on their market capitalisation rates: 

• Micro-cap 

A company with a market capitalisation of less than $300 million. 

• Small-cap 

between $300 million and $2 billion. 

• Mid-cap 

between $2 billion and $10 billion. 

• Large-cap 

a market capitalisation of greater than $10 billion. 

Some have also used mega-cap and nano-cap to refer to enterprises worth more than $200 billion and less than $50 million, respectively. 

Frequently Asked Questions