What is a capitalization (cap) rate?

The capitalization rate (cap rate) is a key metric used to evaluate commercial real estate investments. It is calculated by dividing the property's Net Operating Income (NOI) by its current market value or purchase price. A property generating $120,000 NOI purchased for $1,500,000 has an 8% cap rate. Cap rates reflect the expected rate of return assuming all-cash purchase. Higher cap rates generally indicate higher returns but also higher risk or lower-quality assets. Lower cap rates reflect lower risk, higher-quality locations, or strong tenant demand. Cap rates vary significantly by property type, location, and market conditions.