Change in Asset Value
The cap rate only recognizes the cash flow a real estate investment produces and not the change in value of the property.
To get the unlevered rate of return on an investment the real estate investor adds (or subtracts) the price change percentage from the cap rate. For example, a property delivering an 8% capitalization, or cap rate, that increases in value by 2% delivers a 10% overall rate of return. The actual realised rate of return will depend on the amount of borrowed funds, or leverage, used to purchase the asset.
To calculate the change in asset value, divide the appreciation rate by the percent of investor equity in the property. For example, if the property appreciates 3% this year, and I have 25% equity in the property, my profit is .03 / .25 = .12 = 12%.
Read more about this topic: Capitalization Rate
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