Capitalization Rate (Cap Rate)
A capitalization rate, or cap rate, is a property's annual net operating income divided by its value or purchase price, shown as a percentage. It measures the unlevered return a property produces and gives investors and lenders a quick way to compare pricing across properties and markets.
How to calculate a cap rate
Cap rate = Net operating income ÷ Property value × 100
Example: A property produces $600,000 in net operating income and sells for $10,000,000. Its cap rate is $600,000 ÷ $10,000,000 × 100, or 6 percent. At a 7 percent cap rate, the same income would support a value of about $8.6 million.
Why cap rate matters
Cap rates connect income to value. Because value equals net operating income divided by the cap rate, a small change in the cap rate moves value a lot. That makes the cap rate assumption one of the most important numbers in any valuation.
Cap rates reflect risk and growth expectations. Properties with stable, long-term income in strong markets usually trade at lower cap rates, while properties with more risk or weaker expected growth trade at higher ones. Interest rates also influence cap rates, because they change what investors can earn elsewhere.
Most underwriting models use two cap rates: a going-in cap rate based on today's income and price, and an exit cap rate used to estimate the sale price at the end of the hold period.
Cap Rate vs. Yield on Cost
Cap rate compares current income to current value or price. Yield on cost compares stabilized income to the total cost of a project, including the purchase price and renovation or development costs. Developers and value-add investors compare the two, because a yield on cost well above market cap rates signals that the project creates value.
Where it matters by property type
Cap rates differ by property type and market. Smart Capital Center's underwriting pages cover how they are applied to multifamily, industrial, office and retail properties.
How Smart Capital Center handles cap rates
Smart Capital Center's AI agents pull comparable sales and market cap rates from 1B+ live market data points across 120M+ properties, so each cap rate assumption in the model is backed by current evidence. Analysts choose the final assumption.
Frequently asked questions
Is a higher or lower cap rate better?
It depends on the goal. A higher cap rate means more income per dollar of price, which usually comes with more risk or weaker growth. A lower cap rate means a higher price for the same income, which usually reflects stability and stronger expected growth. Buyers prefer higher cap rates at purchase, and sellers prefer lower ones at sale.
Does the cap rate include mortgage payments?
No. The cap rate uses net operating income, which is measured before debt service. That makes it an unlevered measure that compares properties regardless of how they are financed. Returns after financing are measured with metrics such as cash-on-cash return and the levered internal rate of return.
How do interest rates affect cap rates?
When interest rates rise, investors can earn more from lower-risk investments, so they usually demand higher cap rates from real estate, which pushes values down. When rates fall, cap rates tend to compress. The relationship is not one-for-one, because property fundamentals and capital flows also move cap rates.