Capitalisation rate (taux de capitalisation)

The capitalisation rate, or cap rate (taux de capitalisation in French), is the ratio between the income from a building and its market value excluding transfer costs. Applied in reverse, it values a property from the income it produces: this is the income capitalisation method, commonly used for hotel buildings let to an operator.

Calculation

Value excluding costs = net income / capitalisation rate

Yield = net income / value including costs

Both rates use the same income but not the same value. French valuation practice relates the capitalisation rate to the price excluding acquisition costs, and the yield (taux de rendement) to the buyer’s total outlay, duties and fees included. For the same income, the yield is therefore lower. Always state which rate is meant, and whether income is gross or net of non-recoverable costs.

In the hotel sector

For a let building, the income capitalised is the rent, assessed against what the business can sustain: rent that is too heavy relative to revenue or EBITDA undermines the value of the building itself. For a hotel held as property and business, the approach may use a notional rent and is cross-checked against the EBITDA multiple and values per room.

The rate applied depends on:

• location and the liquidity of the local market
• the remaining fixed term of the commercial lease and the strength of the operator
• rent indexation and how costs and works are shared
• the condition of the building and the CAPEX required
• interest rates at the time of the deal

Not to be confused with

• The EBITDA multiple, which values a business, not a building.
• A low rate with a poor investment: for the same income, a lower rate means a higher value, and rates can only be compared when defined in the same way.

A reasoned valuation sets out the assumptions behind each method.