Cap Rate (Capitalization Rate)
Return metric calculated as NOI divided by property value; used to compare investment properties.
Key Takeaways
- Cap rate compares property values without considering financing costs
- Higher rates mean potentially better returns, but also higher risk
- Always compare similar properties in the same market area
- Cap rate alone doesn't tell the whole story — consider cash flow too
Overview
The Capitalization Rate, commonly referred to as "Cap Rate," is a key metric used by real estate investors to evaluate the profitability of an investment property. You calculate it by dividing the property's Net Operating Income (NOI) by its current market value or purchase price. The cap rate provides a quick way to compare different investment properties and assess their potential return.
Calculation
- Cap Rate = NOI / Property Value (or Purchase Price)
- NOI = Gross Income - Operating Expenses
- Operating expenses include taxes, insurance, maintenance, management fees
- Does NOT include mortgage payments or depreciation
Interpreting Cap Rates
- Higher cap rate = higher potential return, but may indicate higher risk
- Lower cap rate = lower return, but typically lower risk
- Cap rates vary by property type and location
- Used to compare similar properties in the same market
Related Glossary Terms
Related Calculation Tool
Calculate cap rate and investment returns:
AllMoneyCalc - Finance CalculatorFrequently Asked Questions
Cap rate equals Net Operating Income (NOI) divided by the property value or purchase price. You get NOI by subtracting operating expenses from gross rental income.
A "good" cap rate varies by market, but generally ranges from 5% to 10%. Higher-risk areas or properties typically have higher cap rates.
No, cap rate doesn't factor in financing. That's why it's useful for comparing properties — it shows the property's inherent return potential.
Yes, if operating expenses exceed gross income, the cap rate becomes negative. This signals an unprofitable investment.
Each circumstance is different, so this piece offers general guidance. For personalized advice, consult a qualified professional.
For the most accurate details, visit IRS, CRA, HUD, and CFPB directly for the most accurate and up-to-date information.