Cap Rate (Capitalization Rate)
A measure of a property's expected rate of return, calculated by dividing Net Operating Income by the property's value or purchase price.
Definition
The capitalization rate (cap rate) is a fundamental metric in commercial real estate that expresses the relationship between a property's net operating income and its market value. It's used to estimate the potential return on an investment and to compare the relative value of different properties. Lower cap rates generally indicate lower risk and higher property values, while higher cap rates suggest higher risk or lower demand. Small bay industrial properties typically trade at cap rates between 5.5% and 8% depending on market, quality, and tenant mix.
Formula
Cap Rate = Net Operating Income (NOI) / Property ValueExample
A small bay property generates $150,000 NOI annually and is valued at $2,000,000. Cap Rate = $150,000 / $2,000,000 = 7.5%