Cap Rate

A real estate valuation metric showing the expected rate of return on an investment property based on its net operating income.

The Capitalization Rate, or Cap Rate, is a fundamental metric used in commercial real estate to evaluate the profitability and return potential of an asset. It represents the property's net operating income (NOI) as a percentage of its current market value or purchase price. It is calculated by dividing the property's annual net operating income by its current market value. Cap rates move inversely to property values. When cap rates rise (often due to rising interest rates or weakening property demand), property valuations fall. Conversely, falling cap rates indicate rising property values and higher demand. For investors in real estate investment trusts (REITs) or asset managers with large real estate portfolios, tracking cap rates helps assess whether property valuations are expanding or contracting and how interest rate changes are impacting portfolio values.

A commercial office building generates $600,000 in Net Operating Income annually. If the building is valued at $10,000,000, its Cap Rate is calculated as 600,000 / 10,000,000 = 0.06, or 6.0%.