Cap Rate In Real Estate

Real property

: What Is It?

Real estate investors, financiers and developers use cap rate when calculating the potential cost, investment return or return-on-investment for any given property. Cap rate, also known as capitalization rate, is a ratio of the net operating income of a property to its current market value.

How Is Cap Rate Calculated?

The formula for cap rate is:

Net Operating Income (NOI)/ Market Value

NOI is the total amount of income earned from renting an investment property after operating expenses have been taken out of the total amount of rental income.

What Does a High or Low Cap Rate Indicate?

A high cap rate indicates a potentially lower income property, or one that can be improved to generate higher rental income. A low cap rate indicates a more mature or stable market, where the investor might not expect as much financial growth from investing in a property.

Benefits of Knowing a Property’s Cap Rate

Knowing a property’s cap rate can help investors evaluate potential opportunities in the following ways:

  • Assess potential risks
  • Compare different types of investments
  • Compare the financial performance of alternative investments
  • Determine an appropriate price to pay for an investment
  • Make smarter financing decisions

Cap rate is an important metric for real estate investors to understand and use when assessing potential investments. It provides a quick, efficient way to compare properties of different types and in different markets. Having the knowledge to calculate cap rate is a valuable tool for making important real estate decisions.