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What Is A Cap Rate?

Investors have a number of ways to help them measure the value and profitability of rental income property. The most popular metric for investors is the capitalisation rate, or cap rate. The cap rate in real estate is simply the yield, or rate of return, on a property. The cap rate is calculated by dividing the property’s annual net operating income by the market value. Cap rates are an indirect measure of how fast an investment will pay for itself.

What Can The Cap Rate Tell Me?

1. A cap rate can help an investor compare properties.
An investor can use a cap rate to quickly and easily compare properties in a given market to determine which may be a viable investment opportunity.

2. A cap rate can help an investor estimate the value of a property.
If an investors knows the appropriate cap rate for a particular type of rental income property in a certain area, then it is possible to estimate what the property is worth based on its net operating income and prevailing market rate while ignoring the seller’s asking price.

How Do You Calculate The Cap Rate?

The Cap rate calculate is surprisingly simple.

Cap Rate = Net Operating Income ÷  Property Value

For example:

> A 6-unit apartment building valued at 100 million yen and producing an annual operating income of 5 million yen would have a cap rate of 5%.

or

> A studio apartment valued at 28 million yen and producing an annual operating income of 1.9 million yen would have a cap rate of 7%.

How Do I Value Japanese Real Estate Using The Cap Rate?

Again, this useful metric is very simple to calculate.

Value = Net Operating Income ÷ Capitalization Rate


Using the cap rate to determine the value of real estate is known as the income approach to valuation. It assigns a property value equal to the net operating income divided by the cap rate.

For example:

> A small rental property in Tokyo with a net operating income of 10 million yen and a cap rate of 7% would be valued at 143 million yen. The same property with a 10% cap rate would have a value of 100 million yen. So the higher the cap rate, the lower the property’s value.

Limitations Of The Cap Rate As A

Depending on how you value the property the cap rate will change accordingly. Different types of property will have different cap rates so it’s not always useful for direct comparison. A cap rate does not take into consideration appreciation and is also not useful for investors using loan financing, as it will indicate a much lower return-on-cash than is really the case because it is not able to account for leverage. Further, A cap rate may be high for one of two reasons; (1) the property is high risk, or (2) that the property offers high returns and is a great deal. The cap rate in isolation does not tell us about the nature of the returns being offered, only the size of the returns relative to the purchase price.

What Is A “Good” Cap Rate For A Real Estate Investment In Japan?

Unfortunately, there is no such thing as a “good” cap rate as it is all relative to the asset in question. In Japan its possible to see cap rates of 2% for billion dollar prime Tokyo real estate, 6% for high-quality residential property, and all the way up to 14% for distressed assets and renovation ‘turn-around’projects. You may (or may not) be surprised to hear that some of the highest cap-rates are offered by buildings that house questionable tenants like massage parlours and mahjong game rooms….

In Closing

A cap rate does not tell the whole story but it is still a powerful metric for real estate investment. When used alongside other performance and risk metrics you will have a good yard-stick by which to measure both existing, and future potential real estate investments in Japan.

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