The capitalization rate, or cap rate, is a metric investors use to estimate the rate of return on an income-producing property. It is calculated by dividing the property's annual net operating income by its current market value or purchase price.
For example, a property generating 50,000 dollars in net operating income and valued at one million dollars has a five percent cap rate. A higher cap rate generally signals higher potential return but often greater risk, while a lower cap rate suggests a more expensive, potentially safer asset.
Cap rate lets investors compare properties on a level footing regardless of price and helps gauge whether an asking price is reasonable relative to income. It ignores financing, so it reflects the property's unleveraged performance rather than an individual buyer's returns.