Capitalization Rate (Cap Rate)
The ratio of a property's net operating income to its market value or sale price, expressed as a percentage. Used in the income approach to convert a single year's income into a value estimate through direct capitalization.
Cap rate = NOI / Value (or Price). A property with $50,000 NOI and a cap rate of 8% would have an indicated value of $625,000. Lower cap rates indicate lower risk and higher values; higher cap rates indicate higher risk and lower values. Cap rates should be extracted from comparable sales in the market (market extraction method) rather than derived from band-of-investment or other theoretical techniques when possible. Cap rates vary by property type, location, condition, and market conditions. For residential 1-4 unit properties, the GRM technique is more commonly used than direct capitalization.
Related Terms
Net Operating Income (NOI)
NOIThe annual income remaining after deducting all operating expenses from effective gross income, but before deducting debt service (mortgage payments) and income taxes.
Income Approach
A valuation method that estimates a property's value based on the income it generates or is expected to generate.
Gross Rent Multiplier (GRM)
GRMThe ratio of a property's sale price to its gross monthly (or annual) rental income.
Market Extraction
A method of deriving capitalization rates, depreciation rates, or adjustment values directly from analysis of comparable market transactions rather than from theoretical formulas or published sources..
Discounted Cash Flow Analysis (DCF)
DCFA yield capitalization technique that estimates property value by projecting future cash flows (income minus expenses) over a holding period and discounting them to present value using a market-derived discount rate..
More in Income Approach
View allEffective Gross Income (EGI)
EGIPotential gross income minus vacancy and collection losses, plus other income (laundry, parking, late fees).
Vacancy Rate
The percentage of available rental units or space that is unoccupied at a given time.
Market Rent
The rental income a property would most likely command on the open market, based on analysis of comparable rental properties in the area.
Operating Expenses
The recurring costs of owning and operating an income-producing property, including property taxes, insurance, management, maintenance, utilities, and reserves for replacement.