A capitalization rate, or cap rate, in commercial real estate is a metric used to estimate the rate of return on an income-producing property. It is calculated by dividing the property's net operating income (NOI) by its current market value, and is expressed as a percentage:
Cap Rate=Net Operating Income (NOI)Current Market Value×100%\text{Cap Rate}=\frac{\text{Net Operating Income (NOI)}}{\text{Current Market Value}}\times 100%Cap Rate=Current Market ValueNet Operating Income (NOI)×100%
For example, if a property generates $500,000 in NOI and is valued at $5,000,000, the cap rate would be 10% ($500,000 ÷ $5,000,000)
. The cap rate helps investors gauge the potential return on investment and compare the relative value and risk of different commercial properties. A higher cap rate typically indicates higher risk and potentially higher returns, while a lower cap rate suggests lower risk and lower returns. Cap rates vary by property type, location, and market conditions, generally ranging from about 3% to 10% or more
. In summary, the cap rate is a key tool in commercial real estate to assess investment value and risk based on the income a property generates relative to its price
