Capitalization Rate (Cap Rate)
NOI divided by property value, expressed as an annual percentage return on an unleveraged basis.
Definition
The capitalization rate is the yield a buyer would receive if they paid all cash for a property and collected its operating income for a full year. It expresses what the market is willing to pay for a dollar of NOI in a given neighborhood, asset class, and moment in time.
Lower cap rates mean higher prices relative to income, typically in appreciating markets with institutional competition. Higher cap rates mean cheaper prices relative to income, usually in markets with more operational risk or slower appreciation. Comparing cap rates across dissimilar properties is a quick sanity check on relative pricing.
Because cap rate ignores financing, it lets you compare a property bought all cash to one bought with a loan. That makes it useful for valuation and offer modeling, but cash on cash return is the better number once debt enters the picture.
Formula
Example
A property producing $24,000 NOI priced at $300,000 has an 8.0 percent cap rate.
Frequently asked
What is a good cap rate for rental property?
It depends on the market. Class A properties in appreciating markets may trade at 4 to 5 percent. Cash flow markets often see 7 to 10 percent. Compare only to similar properties in the same area.
Does cap rate account for the mortgage?
No. Cap rate is an unleveraged yield. Use cash on cash return to measure performance after debt service.
Related
Run your whole portfolio on autopilot
DoorVault is the AI platform for real estate investors. Upload, forward, or sync. The AI handles the rest.
Start free