What is Cap Rate?
The capitalization rate (cap rate) is one of the most important metrics in real estate investing. It measures the expected rate of return on an investment property based on its income.
Cap rate is calculated by dividing the property's Net Operating Income (NOI) by its current market value or purchase price. A higher cap rate indicates a potentially higher return, but also typically higher risk.
How to Use Cap Rate
Investors use cap rates to:
- Compare properties — Quickly evaluate different investment opportunities
- Assess market conditions — Lower cap rates often indicate stronger markets
- Estimate property value — Divide NOI by market cap rate to estimate value
- Screen deals quickly — Identify properties that meet your return requirements
Typical Cap Rates by Property Type
| Property Type | Typical Cap Rate Range |
|---|---|
| Class A Multifamily | 4.0% - 5.5% |
| Class B Multifamily | 5.0% - 6.5% |
| Class C Multifamily | 6.0% - 8.0% |
| Office (CBD) | 5.0% - 7.0% |
| Retail (NNN) | 5.5% - 7.5% |
| Industrial | 5.0% - 7.0% |
Cap Rate Limitations
While cap rate is useful for quick comparisons, it has limitations:
- Doesn't account for financing or leverage
- Ignores potential for rent growth or appreciation
- Doesn't factor in capital expenditures
- Static snapshot — doesn't project future performance
For a complete investment analysis including IRR, cash-on-cash returns, and risk modeling, you need a full pro forma.