Capitalization Rate (Cap Rate)
A rate used to estimate the value of income-producing property, calculated as Net Operating Income divided by property value.
Full Definition
The capitalization rate (cap rate) is the ratio of a property's Net Operating Income (NOI) to its market value or purchase price, expressed as a percentage. Cap Rate = NOI ÷ Property Value. It is used to estimate the value of income-producing properties and to compare investment opportunities. A higher cap rate indicates higher return but also higher risk (or a lower-priced property relative to income). A lower cap rate indicates lower risk and is typical of properties in prime locations with stable tenants. To find property value using cap rate: Value = NOI ÷ Cap Rate. Cap rates do not account for financing, so they reflect property performance independent of how it was purchased.
Real-World Example
A commercial property generates $60,000 NOI annually. Similar properties in the area sell at a 6% cap rate. Estimated value = $60,000 ÷ 0.06 = $1,000,000.
How Capitalization Rate (Cap Rate) Appears on the Real Estate Exam
Common question types, tested concepts, and what to watch out for
Three formulas to know: Cap Rate = NOI ÷ Value; Value = NOI ÷ Cap Rate; NOI = Value × Cap Rate. A rising cap rate means falling property values (inverse relationship). Cap rate does not include debt service.
Related Terms
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