Capitalization Rate (Cap Rate)
The Cap Rate expresses the relationship between a property's annual net operating income and its market value—the unlevered yield before financing costs.
What You Will Learn: You'll discover how Cap Rate expresses the relationship between a property's income and its value. Learn how to calculate cap rates, interpret them across markets, and use them to compare investment opportunities and assess property valuations.
Definition
The Cap Rate expresses the relationship between a property's annual net operating income and its market value or purchase price. It's the unlevered yield an investor can expect before financing costs.
Formula
Cap Rate = (NOI / Property Value) × 100or rearranged...
Property Value = NOI / Cap RateExample Calculation
Annual NOI: $75,000
Purchase Price: $1,000,000
Cap Rate = ($75,000 / $1,000,000) × 100 = 7.5%
For every dollar invested, you're earning 7.5 cents in annual income before debt service.
Cap Rate Comparison Example
Three properties, all priced at $1,000,000:
| Property | NOI | Cap Rate | Interpretation |
|---|---|---|---|
| Property A | $75,000 | 7.5% | Standard risk/return profile |
| Property B | $60,000 | 6.0% | Premium asset - lower yield reflects lower risk |
| Property C | $90,000 | 9.0% | Value opportunity or higher risk |
Key Insight: Lower cap rates indicate investors are willing to pay more per dollar of income, typically reflecting lower perceived risk, stronger growth prospects, or more desirable locations.
What Drives Cap Rates
Interest Rate Environment
Higher rates → Higher cap rates (lower valuations)
Property Risk Profile
Stable assets → Lower cap rates; Riskier assets → Higher cap rates
Growth Expectations
Strong prospects → Lower cap rates; Limited growth → Higher cap rates
Market Liquidity
Deep buyer pools → Lower cap rates; Limited buyers → Higher cap rates
Cap Rate Interpretation Guide
| Range | Asset Type | Profile |
|---|---|---|
| 3-5% | Premium Assets | Core+ properties, major metros, institutional quality |
| 5-7% | Core Properties | Stabilized assets, good locations, lower risk |
| 7-10% | Value-Add | Secondary markets, operational improvements needed |
| 10%+ | Opportunistic | Higher risk, turnaround situations, tertiary markets |
Current Cap Rates by Property Type (2024)
| Property Type | Cap Rate |
|---|---|
| Multifamily | 5.5% |
| MHC | 6.2% |
| Self-Storage | 6.5% |
| Retail | 7.8% |
| Office | 8.5% |
Critical Warning
Cap rate is a snapshot metric that ignores leverage, growth, and time value of money. Two properties with identical 7% cap rates can deliver vastly different total returns if one grows NOI at 5% annually while the other stagnates. Always evaluate cap rate alongside NOI growth trends, financing costs, and your required return threshold.
Where to Find This on Our Site
See Cap Rate analysis in action on our Research & Market Insights page, featuring:
- Property valuation comparisons using cap rates
- NOI-to-value relationship analysis
- Market cap rate trends and comparisons
Related Terms
Explore Investment Opportunities
View properties with attractive cap rates and strong NOI growth potential.
View Opportunities