Capitalization Rate (Cap Rate)
Standard Definition
A ratio used to estimate the rate of return on an investment property, calculated by dividing the Net Operating Income (NOI) by the purchase price or current value.
Detailed Examination Analysis
The Capitalization Rate (Cap Rate) is a fundamental metric used by real estate investors to compare the profitability of commercial and multifamily residential properties. The formula is: Cap Rate = NOI / Current Value. A higher cap rate indicates a higher potential return, but also a higher risk. Conversely, a lower cap rate indicates a lower return, typically associated with safer properties in prime locations.
Real-World Examination Scenario
"An investor purchases a small retail strip mall for $1,200,000. The property generates $96,000 in Net Operating Income annually. The cap rate is calculated as $96,000 / $1,200,000 = 0.08, or an **8% Cap Rate**."
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