Capitalization (Cap) Rate
Cap rate is the rate of return for a property based on its annual income. It is calculated by dividing the net operating income of the property by the total value of the property. Cap rates can provide a good initial measure to compare different investment opportunities but should not be the sole factor considered. While a meaningful way to assess risk and value, they are best understood within the context of the particular market the property is found in and by their relationship to prevailing interest rates. The most competitive primary markets, like NYC, frequently have far lower cap rates than secondary or tertiary markets. When analyzing the assumptions made by Sponsors about the sale of an asset, real estate investors will frequently look at the assumed exit Cap Rate and test the impact on their net returns if the assumption is incorrect.
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