Capitalization rate (cap rate) is a fundamental metric in commercial real estate, but it often causes confusion for new investors.
Simply put, the cap rate is the expected rate of return generated on a real estate investment property, assuming the property is purchased with cash.
- Formula: Net Operating Income (NOI) / Current Market Value
- High Cap Rate: Typically indicates higher risk and potentially higher return.
- Low Cap Rate: Typically indicates lower risk, often found in prime locations with stable tenants.
Bottom Line
Cap rates are a helpful tool for comparing properties, but they should never be the only metric you use to evaluate a deal.
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