Capitalisation rate (Cap Rate)

The capitalisation rate (cap rate) is the discount rate applied to a normalised annual income stream to derive directly the value of an asset or business: V = I / r. It is the inverse of the implied multiple: a cap rate of 12.5% corresponds to an 8x multiple (1 / 12.5% = 8). The cap rate is a simplified single-period valuation method appropriate for businesses with stable, recurring cash flows — commonly used in commercial real estate, concession valuations, and businesses with predictable perpetual earnings.

In business valuation, the cap rate is applied to the normalised free cash flow or EBITDA in a direct capitalisation approach (single-period capitalisation). It is the limit of the Gordon-Shapiro formula when growth approaches zero: r = WACC − g. For a business with no long-term growth (mature activity, time-limited concession), the cap rate and the WACC converge. In Swiss commercial real estate, cap rates for prime assets in Lausanne compressed from 5–6% in 2015 to 3–4% in 2022–2023, reflecting the search for yield in a low interest rate environment.

The key distinction between the cap rate and the discount rate (WACC) is the modelling approach: the WACC is used to discount cash flows period by period in a multi-period DCF model; the cap rate is applied to a single normalised income in perpetuity. The cap rate is a robust and auditable method when the normalised income is well-established — but unreliable when cash flows are volatile or growth-dependent.

At Hectelion, we use the capitalisation rate as a cross-check method in our business valuations for stable, recurring-income businesses in the Franco-Swiss market.