The capitalization rate, or cap rate, expresses the relationship between a property’s net operating income (NOI) and its value. Calculated as NOI divided by value (or purchase price), it represents the unlevered yield an investor would earn in the first year. Cap rates are used both to value a property (value = NOI ÷ cap rate) and to compare assets: lower cap rates generally signal lower perceived risk or stronger markets, while higher cap rates signal higher risk or weaker demand.
Cap Rate = Net Operating Income ÷ Property Value
Using cap rate to value a property
Rearranging the formula gives a quick valuation: Value = NOI ÷ Cap Rate. If a market trades at a 6% cap rate and a property produces $600,000 of NOI, its implied value is about $10,000,000.
What cap rates tell investors
Cap rates reflect risk and growth expectations, not just yield.
- Lower cap rate — higher price relative to income, often lower perceived risk
- Higher cap rate — lower price relative to income, often higher perceived risk
- Cap rates compress in strong markets and expand when rates or risk rise
A property with $750,000 of NOI sells for $12,500,000. Its cap rate is 750,000 ÷ 12,500,000 = 6.0%.