Capitalization Rate (Cap Rate)

A Capitalization Rate (Cap Rate) indicates the expected rate of return on an income-generating asset by dividing its net operating income (NOI) by the acquisition cost or current value. The result is a percentage representing annual yield based on stable operational assumptions. Higher cap rates may signal higher risk or undervalued items, while lower rates reflect stable markets or prime assets.

Key Points:

• Snapshot Metric: Focuses on a single year’s performance, assuming no major changes.
• Comparison Tool: Useful in evaluating multiple opportunities for consistent ROI approximations.
• Market Dependent: Local supply-demand, occupant profiles, or asset age can sway cap rates.
• Risk Indicator: Higher percentage often correlates with uncertain or emerging environments.

Cap rates help prospective buyers gauge potential returns, ensuring decisions align with desired risk tolerance and financial strategies.