Capitalization Rate

Definition of "Capitalization rate"

Also called cap rate or income yield. A useful way to compute the rate of return on a real estate investment. It equals the net operating income (NOI) for the first year divided by the total investment. That interest rate that, when applied to the earnings of an investment, determines its market value. The lower the cap rate, the higher the risk to the investor and the higher the asking price. Whether property is overpriced depends on the rate for similar property in the market. There are two drawbacks to this approach: (1) it is based on only the first years NOI, and (2) it ignores the appreciation in property value.

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