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How It Works
The cap rate expresses a property's net operating income as a percentage of its market value. It gives investors a quick way to compare returns across properties without factoring in financing.
A higher cap rate suggests higher returns but often higher risk. Properties in prime locations typically have lower cap rates (4–6%) while riskier markets may see rates of 8–12%.
Example Problem
A commercial building generates $75,000 in NOI and is valued at $1,000,000.
- Cap Rate = $75,000 / $1,000,000 = 0.075
- Multiply by 100: 7.5%
Alternatively, if you know the cap rate is 7.5% and NOI is $75,000, the property value is $75,000 / 0.075 = $1,000,000.
Frequently Asked Questions
What is a good cap rate for investment property?
It depends on market and risk. Class A properties in major cities often have cap rates of 4–5%, while value-add or suburban properties may range from 7–10%. Compare within the same asset class for meaningful results.
Does cap rate include mortgage payments?
No. Cap rate uses net operating income before debt service. This makes it useful for comparing properties regardless of how they are financed. Use cash-on-cash return to account for leverage.
How do cap rates relate to property value?
Cap rate and value move inversely. If cap rates compress from 8% to 6% while NOI stays at $80,000, the property value rises from $1,000,000 to $1,333,333. Falling cap rates signal rising property prices.
Related Calculators
- Net Operating Income Calculator — compute NOI for cap rate analysis.
- Cash on Cash Rate Calculator — measure returns after financing.
- Gross Rent Multiplier Calculator — quick screening metric for rentals.
- Return on Equity Calculator — measure leveraged returns on your equity position.
Reference: Brueggeman, William B. & Fisher, Jeffrey D. Real Estate Finance and Investments. McGraw-Hill Education.