Cap Rate, short for “Capitalization Rate” is a term used in real estate investing as one measure of investment return. It is calculated by dividing the Net Operating Income (NOI) the property generates by the current market value of the property.
For example, if a property is for sale for $100,000 and will generate $10,000 in income after expenses like maintenance and taxes, then the cap rate is 10% ($10,000/$100,000). Note that if the market value of a property increases faster than NOI, then the cap rate will decline. That is common in areas with high property appreciation relative to rental rates. Note also that the NOI does not include interest expenses, as it’s intended to provide an “apples-to-apples” comparison of a property’s profitability irrespective of how the property is financed).
If you’re familiar with stock investing, Cap Rate is roughly analogous to Earnings Yield (the inverse of the P/E ratio).
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