Cap rate (capitalization rate) is the ratio of a property’s annual net operating income (NOI) to its current market value or acquisition price. Net operating income is rental income minus operating expenses, excluding debt service and taxes. The cap rate is expressed as a percentage and reflects the income-producing efficiency of the property relative to its price.
Investors use cap rate to compare similar income properties, screen potential acquisitions, and derive a rough estimate of property value given a target NOI. The basic formula is cap rate = NOI ÷ property value. A property with a higher cap rate relative to peers may indicate a larger income stream relative to price, but differences in risk, tenant quality, location, and operating expenses can drive those variations. Cap rates are most meaningful for stabilized properties with predictable cash flows; for properties with vacancies or atypical expenses, the NOI figure may be less reliable. Market cap rates can also vary by asset class (e.g., multifamily, office, industrial) and by local conditions. Real estate professionals distinguish between going-in (or market) cap rates and replacement or reversion considerations, and may compare cap rates to expected internal rates of return when evaluating longer-term investment plans.
Cap rate relies on NOI and market value, both of which can be affected by accounting choices, capital expenditures, and market cycles. It does not incorporate financing terms or tax considerations and is not a guaranteed predictor of future cash flows.
A property with NOI of $90,000 and a market value of $1,000,000 yields a cap rate of 9%.
Net Operating Income (NOI) · Going-in Cap Rate · Market Value · Property Valuation · Internal Rate of Return (IRR) · Cash-on-Cash Return