What is a cap rate?

A cap rate, short for capitalization rate, is indeed a measure of return on investment for real estate. It is a crucial metric used by real estate investors to assess the potential profitability of an income-generating property. The cap rate is calculated by taking the property's net operating income (NOI) and dividing it by the current market value or purchase price of the property. This results in a percentage that reflects the expected rate of return on the investment if it were purchased with cash.

This percentage helps investors compare different investment opportunities regardless of their value or location. A higher cap rate typically indicates a potentially higher return on investment, suggesting that the property might be riskier or undervalued. Conversely, a lower cap rate may suggest a more stable investment or a property that is overvalued.

Understanding the cap rate is essential for making informed decisions in real estate investments, as it quantifies the income generated relative to the property's value, thus providing insight into its investment potential.