CAP Rate Definition

CAP rates or Capitalization rates are a ration that is used by investors to estimate the overall value of a property that is meant to produce income. The simple version of the ration is to say that the CAP rate is the net operating income divided by the price or value. It is generally expressed in the form of a percentage.

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What good are CAP Rates?

CAP rates are used by lenders, appraisers, and investors alike to estimate the price for various income producing pieces of property. For a particular market, the cap rates of similar properties in the area are used to estimate CAP for any other given property.

How are CAP rates figured?

Cap rate comes from a simple ration expressed into a percentage. First, the net operating income (NOI) or a property is taken. The NOI is the amount of money that is left after all operating expenses are deducted from the gross income of the property (rent or lease payments in many cases). That number is then divided by the price of the property. What the number basically expresses is the projection of what you might earn on the property if you paid cash for it.

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What do you do with CAP rates?

The CAP rate can show you what your future earnings, after finance costs and interest are gone, may be on the property. Additionally, if you have the NOI to use in the figure, you also know going in whether or not your property is income producing property. That is, you have built in way of knowing if you are being had or not.

Overall, the cap rate can be valuable, but you should be aware of how it is figured. Once you know where the number comes from, you can take it for what it is. It is not a way of figuring return when you finance a property and it does not take into account differences in financing options. It can be a valuable tool, just make sure you use it and figure it correctly.