Cap Rate

Cap rate (capitalization rate) is a property's net operating income divided by its purchase price, expressed as a percentage.

Cap rate — capitalization rate — is a property's net operating income divided by its price, expressed as a percentage. It measures what the property earns as an investment before any financing: a property with $12,000 of NOI priced at $150,000 has an 8% cap rate. Because the mortgage is left out, cap rate lets you compare two properties on their own merits regardless of how each buyer would finance them.

Cap rate also works in reverse, which is how investors use it to price deals. If similar rentals in a neighborhood trade at an 8% cap and a property produces $10,000 of NOI, that suggests a value around $125,000. Lower cap rates mean buyers are paying more for each dollar of income — typical of stable, desirable areas — while higher cap rates mean cheaper income, usually with more risk attached.

Beginners get cap rate wrong in two ways. First, they compute it with gross rent instead of net operating income, which inflates the number badly — the formula only works after real operating expenses come out. Second, they treat a high cap rate as automatically better. A 12% cap in a rough market with heavy turnover can perform far worse in practice than a 7% cap on a stable block. Cap rate is a comparison tool, not a verdict; use it to rank similar deals in similar areas, then underwrite the winner with real numbers.