Definition
The capitalization rate is a measure of a property's expected return, calculated as net operating income divided by purchase price.
How It Works
Cap rate equals annual net operating income divided by the property's value or price. A higher cap rate generally signals higher return and often higher risk, while a lower cap rate signals a more stable or sought-after asset.
Example
A property generating $80,000 of net operating income that costs $1 million has an 8% cap rate.
When It Works Best
Cap rate is most useful for comparing similar income properties in the same market.
Who It Applies To
Real estate investors evaluating income properties.
Watch-Outs
Cap rate ignores financing and assumes a single year's income, so it is a starting screen rather than a complete analysis.
