Definition
Cap Rate (Capitalization Rate)
Also called: capitalization rate, cap rate formula
A cap rate is a property's annual net operating income divided by its price. Investors use it in reverse to price income property: a park or building netting $100,000 a year at an 8% cap rate is worth about $1.25 million, and a lower cap rate means a higher price for the same income.
Net operating income (NOI) is the rent actually collected plus other income, minus operating costs: property taxes, insurance, any utilities the owner pays, management, repairs, and a vacancy allowance. Loan payments and depreciation are left out, because the cap rate measures the property, not the financing. Buyers recompute NOI from bank statements, tax bills, and utility invoices rather than trusting a seller's summary, and the number they arrive at is the one they capitalize.
What moves the cap rate is risk and competition: asset type and class, the market, who pays the utilities, the condition of the infrastructure, and tenant quality. Stabilized properties in strong metros trade at lower cap rates than small, private-utility, or turnaround properties, and ranges vary by market and year. The spread matters: the same $100,000 of income is worth about $1.67 million at a 6% cap and about $1.11 million at a 9% cap, a one-third difference in price. That is why sellers of multi-family, commercial, and mobile home park property should collect several buyers' numbers rather than accept one.
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