What is a Cap Rate?

A Capitalization Rate (Cap Rate) is a key metric in commercial real estate used to estimate an investment property’s expected return based solely on its income.

It is calculated by dividing the property’s Net Operating Income (NOI) by its Purchase Price.

Cap Rate = NOI ÷ Purchase Price

What Cap Rate Tells an Investor

• Return on Investment: Shows the approximate annual return if the property were bought in cash.
• Risk Indicator:
• Higher cap rates usually mean higher risk and higher potential return.
• Lower cap rates typically indicate lower risk but also lower returns.
• Market Comparison: Helps compare properties across different markets, asset classes, or locations.

Simple Example

A property that generates $100,000 in NOI and is priced at $1,250,000 has an:

Cap Rate = 100,000 ÷ 1,250,000 = 8%

Summary

"Cap Rate helps investors understand the potential return and risk of a commercial property. It shows how much income the property generates compared to its price, making it easier to compare investment opportunities."