Capitalization Rate (Cap Rate)

Cap rate is the ratio of a property's net operating income to its current market value or purchase price, used to compare relative pricing across income-producing real estate. Lower cap rates indicate higher prices relative to income (typically lower-risk, higher-demand assets), while higher cap rates indicate cheaper pricing relative to income (typically higher perceived risk).

Formula: Cap Rate = Net Operating Income ÷ Property Value (or Purchase Price) × 100

Cap rate is the primary shorthand investors and appraisers use to compare pricing across properties and markets, because it normalizes purchase price against the income the asset actually produces. A 5% cap rate multifamily property in a gateway city and an 8% cap rate industrial property in a secondary market can both be reasonably priced for their respective risk profiles — cap rate alone doesn't tell you which is the better deal, only how the market is pricing the income stream.

Cap rates move inversely with buyer demand and available capital: when interest rates rise and financing gets more expensive, cap rates tend to expand (prices fall relative to income) because buyers need higher unlevered returns to compensate for pricier debt. Conversely, when capital is abundant and rates are low, cap rates compress and prices rise relative to income.

Appraisers derive cap rates from recent comparable sales in the same submarket and asset class, then apply that rate to a subject property's NOI to estimate value via the income approach — one of three standard valuation methods alongside the sales comparison and cost approaches.

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