What Is Capitalization Rate (Cap Rate)?

The capitalization rate — universally called the cap rate — is the return a property would generate if purchased with all cash (no mortgage). Formula: Cap Rate = NOI ÷ Purchase Price A property with $200,000 NOI selling for $3,000,000 has a 6.67% cap rate.

The capitalization rate — universally called the cap rate — is the return a property would generate if purchased with all cash (no mortgage).

Formula: Cap Rate = NOI ÷ Purchase Price

A property with $200,000 NOI selling for $3,000,000 has a 6.67% cap rate. Flip the formula and you get the implied value: Value = NOI ÷ Cap Rate. If the market consensus for that asset class in that submarket is a 6.5% cap, the implied value is $200,000 ÷ 0.065 = $3,076,923.

Cap rate is the market’s pricing language. When a broker says “this is a 5-cap deal,” they mean you’ll earn 5% on your purchase price before financing, before taxes, before depreciation. When they say cap rates are compressing, they mean prices are rising relative to income. When they say cap rates are expanding, prices are falling or income hasn’t kept up.

Two things drive cap rates: risk and growth expectations. A 4.5% cap rate in a gateway city (Manhattan, LA) reflects low perceived risk and strong rent growth expectations. A 9% cap rate in a rural secondary market reflects higher perceived risk and slower growth. You’re not getting a “better deal” with a 9-cap unless you believe the income is stable and the risk is manageable.

One warning: cap rate assumes stabilized, operating income. Don’t apply it to a property still in lease-up or mid-renovation. (How the same building can be worth one number “as-is” today and a different number once it’s stabilized — and how replacement cost sets a ceiling on price — is its own topic. You’ll go deep on those valuation methods in I1: Valuation.)

Learn this properly

Cap Rate is one of the core numbers in commercial real estate. The Language of CRE course teaches it alongside every other metric you need to read a deal, with worked examples and practice questions.

[Start with The Language of CRE ($49)](/courses/f2/) · [Open the CRE calculators](/cre-calculators/)

Common questions

What is Capitalization Rate (Cap Rate)?

The capitalization rate — universally called the cap rate — is the return a property would generate if purchased with all cash (no mortgage). Formula: Cap Rate = NOI ÷ Purchase Price A property with $200,000 NOI selling for $3,000,000 has a 6.67% cap rate.

Why does Cap Rate matter in a commercial real estate deal?

Flip the formula and you get the implied value: Value = NOI ÷ Cap Rate. If the market consensus for that asset class in that submarket is a 6.5% cap, the implied value is $200,000 ÷ 0.065 = $3,076,923.

Related terms

[Cash Flow Before Tax (CFBT)](/cash-flow-before-tax/) · [Cash-on-Cash Return](/cash-on-cash-return/)

Educational definition only. Not investment, financial, or brokerage advice.