How is capitalization defined in real estate?

In real estate, capitalization is primarily defined as a formula for estimating property value based on its net income. This method, often referred to as the income approach to valuation, involves calculating the expected income a property generates and applying a capitalization rate (cap rate) to determine its worth. The cap rate is derived from the relationship between the net operating income (NOI) and the property’s current market value or the purchase price. This approach is particularly useful for investors looking to assess the profitability and value of income-generating properties, such as rental buildings or commercial real estate.

Understanding this concept is crucial for real estate professionals as it assists them in evaluating investment opportunities and making informed decisions regarding property purchases and sales. Other options, while related to real estate practices, do not accurately describe capitalization in the context of property valuation.