Cap Rate

The capitalization rate, or cap rate, is a fundamental real estate metric that expresses a property's unlevered annual return as a percentage of its value. It is calculated by dividing net operating income (NOI), the property's rental income less operating expenses but before debt service and income tax, by the property's market value or purchase price. A building generating $600,000 of NOI and valued at $10 million has a 6% cap rate. The cap rate is essentially the inverse of a price-to-earnings multiple for real estate: a lower cap rate means investors are paying more for each dollar of income, typically reflecting lower perceived risk, stronger location, or higher expected growth, while a higher cap rate signals more risk or weaker growth prospects and a lower price relative to income. Cap rates move inversely to prices, so when cap rates rise, property values generally fall, all else equal. Investors use cap rates to compare properties, gauge whether a price is reasonable, and track market sentiment by asset class and region. Cap rates are a snapshot of in-place income and do not account for financing, capital expenditures, lease rollover, or future rent growth, so they should be one input among several rather than a standalone valuation.