CAP Rates, ROI and Discounted Cash Flow Analysis

For investors or companies that purchase real estate as an investment, the real estate is bought as a means to make money and defer taxes. Hopefully the investment also increases in value. Some of the most widely employed measures by which investors judge the performance of a real estate investment are;

CAP rate or Capitalization Rate
ROI or Return on Investment and
DCFA or Discounted Cash Flow Analysis

Capitalization rate (or “cap rate“) is a real estate valuation measure used to compare different real estate investments. Although there are many variations, a cap rate is often calculated as the ratio between the net operating income before taxes produced by an asset and the original asset cost or alternatively its current market value. CAP rate doesn’t take into consideration the cost of money or financing.

ROI or Return on investment is a financial analysis term. Return on investment (ROI) is a ratio between net profit after financing costs (over a period) and the cost of investment. ROI is generally calculated based on pre-tax earnings. A high ROI means the investment’s gains compare favorably to its cost. As a performance measure, ROI is used to evaluate the efficiency of an investment or to compare the efficiencies of several different investments.[1] In economic terms, it is one way of relating profits to capitol invested.

Discounted cash flow (DCF) is a valuation method used to estimate the value of an investment based on its expected future cash flows. DCF analysis attempts to figure out the value of an investment today, based on projections of how much money it will generate in the future taking into consideration the period of the investment, interest rates.

CAP rate, ROI and DCF analysis are important benchmarking tools that give an investor an indication of how the performance of various investments compares.

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