Cap Rate
Capitalization Rate — a key metric for evaluating and comparing investment properties.
Definition
Cap rate measures the rate of return on a real estate investment based on the income the property is expected to generate. It's calculated by dividing the property's Net Operating Income (NOI) by its current market value.
Cap Rate = NOI ÷ Property Value
Example: $24,000 NOI ÷ $300,000 = 8% cap rate
How to Use Cap Rate
- Compare properties — Higher cap rate = higher potential return (but often more risk)
- Estimate value — If you know the NOI and market cap rate, you can estimate value
- Screen deals quickly — Cap rate gives a quick snapshot of return potential
What's a Good Cap Rate?
This varies by market, property type, and condition. In general:
- 4-6% — Typical for prime urban areas with lower risk
- 6-8% — Moderate returns in suburban or secondary markets
- 8%+ — Higher returns but may indicate higher risk or deferred maintenance
Limitations
Cap rate doesn't account for financing, appreciation potential, or capital expenditures. Use it alongside other metrics like cash-on-cash return and DSCR for a complete picture.