Capitalization Rate:

The capitalization rate (Cap Rate) is a financial metric that measures the return on investment (ROI) of a real estate property. It represents the percentage of the property’s value that is generated by its annual net operating income (NOI).

Formula: Cap Rate = NOI ÷ Property Value

Interpretation:

• A higher Cap Rate indicates a more attractive investment opportunity, as it means the property is generating more cash flow relative to its value.

• A lower Cap Rate may indicate a less attractive investment, as the property’s cash flow is relatively lower compared to its value.

Example: If a $100,000 rental property has an NOI of $6,000 per year, its Cap Rate would be 6% ($6,000 ÷ $100,000).

Importance of Capitalization Rate:

The Cap Rate plays a crucial role in evaluating the viability and potential returns on investment for real estate properties. It helps investors assess whether a property’s value is justified by its cash flow.