What Is a CAP Rate?
A simple way to understand capitalization rates and how they help compare commercial real estate investments.
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A capitalization rate, usually called a cap rate, is a quick way to estimate the return a commercial property could generate based on its income and purchase price.
The formula
For example, if a property produces $100,000 in annual net operating income and is worth $2,000,000, its cap rate is 5%.
What it tells you
Cap rates help investors compare properties in a similar market. In general, a higher cap rate can mean a higher potential return, but it may also reflect more risk. A lower cap rate often suggests a property is viewed as more stable, desirable, or likely to grow in value.
What cap rates do not include
Cap rate is a useful starting point, not a complete investment analysis. It does not account for financing, income taxes, future rent growth, major repairs, or the timing of cash flows. Review those factors alongside the cap rate before making a decision.