Capitalization Rate (Cap Rate)
NOI divided by property value — the property's return if bought all-cash.
Definition
Cap rate normalizes returns by removing financing from the equation. A 7% cap rate means the property earns 7% of its value annually in net operating income. Higher cap rates = higher returns but usually higher risk areas. Lower cap rates = expensive markets, lower risk, lower cash flow. Cap rates are most useful for comparing markets and property types, not for evaluating individual deals.
Formula
Cap Rate = NOI / Property Value × 100
Pro Tip
Don't chase cap rates. A 10% cap rate in a declining neighborhood is worse than a 5% cap rate in a growing market. Cap rate doesn't capture appreciation or neighborhood trajectory.
Related Terms
Educational content only. Consult a CPA or attorney for advice specific to your situation.