What Is Cap Rate (Capitalization Rate)?

Cap rate is calculated as: Net Operating Income (NOI) ÷ Property Value (or Purchase Price). For example, a property generating $60,000 in annual NOI purchased for $1,000,000 has a 6% cap rate. NOI is revenue (typically rent) minus operating expenses — excluding mortgage payments, which makes cap rate a financing-neutral metric useful for comparing properties regardless of how they are financed. A lower cap rate generally indicates lower risk and/or higher demand (common in prime urban markets). A higher cap rate signals either higher risk or lower market demand — but also potentially higher returns. Cap rates vary significantly by property type (industrial, multifamily, retail, office) and location. In a rising rate environment, cap rates tend to expand (property values fall) because investors demand higher returns to compete with risk-free alternatives like Treasury bonds.

Cap rate is a starting point, not a complete picture — it doesn't account for vacancy, capital expenditure needs, or financing costs. Before purchasing an investment property, a real estate advisor can help you analyze NOI quality, benchmark cap rates against comparable properties in the market, and model cash-on-cash returns that reflect your actual financing structure.