The capitalization rate (cap rate) is a property's net operating income divided by its price or value, expressed as a percentage. It measures the return the property itself produces before any financing — two investors with different loans can compare the same building by cap rate. Cap rate is not cash flow and not a full return measure: it ignores debt, and it is only as honest as the NOI underneath it.
The formula / structureCap Rate = NOI ÷ Property Price (or Value)
Cap Rate: a worked example
Worked example. A rental produces $18,000 a year in NOI. At a price of $260,000, cap rate = $18,000 ÷ $260,000 = 6.9%. At a price of $300,000 for the same NOI, the cap rate falls to 6.0% — the property did not change; the price did.
What affects Cap Rate
- NOI accuracy — understated expenses inflate the rate
- Price paid or appraised value
- Market norms — cap rates differ by city, property class, and interest-rate environment
- Rent growth and expense expectations (buyers accept lower cap rates where growth is expected)
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