What Is Cap Rate?
Cap rate estimates a rental property's annual return based on its net operating income relative to its price or value, before financing costs.
Advanced Explanation
Cap rate is NOI divided by value or price - an unlevered, single-year yield measure. In direct capitalization, value = NOI ÷ cap rate, so small cap-rate changes move value substantially. Going-in cap rates use current or forward NOI at purchase; exit (terminal) cap rates estimate value at sale. Cap rate ignores financing, capital expenditures below NOI and income growth.
Formula
Cap Rate = Net Operating Income ÷ Property Value × 100
Example
A $400,000 rental generating $24,000 in annual NOI has approximately a 6% cap rate.
Why It Matters
Investors use cap rate to quickly compare income-producing properties on an apples-to-apples basis, independent of how each is financed.