Capitalization Rate

In real estate valuation, the capitalization rate, or cap rate, is the percentage used to convert a property’s net operating income into an estimate of its market value through the process of capitalization. It represents the rate of return an average investor would expect in order to be compensated for the risks and characteristics associated with a particular type of income-producing property. The selected capitalization rate reflects market conditions, investor expectations, property location, and the stability of income, and it is applied by dividing the annual net income by the cap rate to determine value. Because the cap rate serves as a yield rate, it plays a central role in income-based valuation and helps investors compare the relative attractiveness of different real estate investments.