The cap rate, an abbreviation for “capitalization rate,” is a real estate metric that reflects the expected rate of return on rental property investments.

The Cap Rate, or “Capitalization Rate,” is a fundamental real estate valuation ratio that compares a rental property investment’s annual net operating income (NOI) to its current market value.

The cap rate formula is the ratio between a rental property’s net operating income (NOI) and its fair market value (FMV) as of the present date, expressed as a percentage.

• The cap rate is defined as the potential rate of return on a rental property building, such as a commercial real estate investment.
• The cap rate formula divides the net operating income (NOI) of a rental property at stabilization by the property’s market value as of the present date.
• < UNK> Real estate practitioners frequently use the cap rate to compare different investment opportunities to determine the property with the most attractive risk-return profile.
• The higher the cap rate, the higher the risk and potential return – all else equal.
• There is no reasonable cap rate, per se, because the decision is subjective and contingent on the specific investor’s risk-return profile. Still, most commercial real estate investors target a cap rate between 4% to 10%.