Cap Rate (Capitalization Rate)
The capitalization rate is a property's net operating income divided by its value or purchase price. It expresses the unlevered annual return: a building bought for $10 million producing $600,000 NOI trades at a 6% cap rate. Lower cap rates mean higher prices and typically signal lower perceived risk.
Cap Rate = NOI ÷ Property Value × 100Cap rates vary by market and asset class. Stabilized multifamily in major markets typically trades at lower cap rates than hotels or suburban office, reflecting the market's view of income durability.
Cap rates also convert income to value in appraisals and underwriting: value = NOI ÷ cap rate. This is why lenders scrutinize both the NOI and the cap rate assumption — a 50 basis point cap rate change moves value by roughly 8%.
$560,000 NOI ÷ 5.5% cap rate = ~$10.2 million implied value.
Frequently asked questions
What is the difference between a cap rate and a market cap rate?
A property's cap rate comes from its own net operating income and price. A market cap rate is what comparable stabilized assets in that submarket trade at — the figure appraisers and lenders use to convert income into value. Relendi's published benchmarks put stabilized New York office at 6.0% and Florida office at 6.5%.
Why is it called a capitalization rate?
Because it capitalizes income into value: dividing a single year's net operating income by the rate produces the property's implied value. The term comes from appraisal practice, where direct capitalization converts one stabilized year of income into a price instead of discounting a multi-year cash flow.
Is a higher or lower cap rate better?
Neither is universally better — it depends which side of the trade you are on. A lower cap rate means a higher price per dollar of income, which favors sellers. A higher cap rate means a cheaper entry and more current yield, but it typically reflects greater perceived risk, weaker tenancy, or a thinner market.
What is the difference between cap rate and ROI?
Cap rate is unlevered and single-year: net operating income over value, ignoring financing entirely. Return on investment and cash-on-cash return measure what the equity earns after debt service, so leverage moves them without ever moving the cap rate. Two buyers of the same building share its cap rate and can still earn very different returns.
How do lenders use cap rate in commercial underwriting?
Lenders convert net operating income into value at a market cap rate, and that value is the denominator in LTV — so the cap rate assumption helps size the loan. Credit committees typically underwrite to benchmark cap rates rather than the seller's, then check that the resulting loan still clears the minimum DSCR.