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Capitalization Rate (Cap Rate): The cap rate is a good point in evaluating commercial real estate, but it is only one of many factors. The cap rate is also the rate of return on a real estate investment property based on the income that the property is expected to generate for you, net operating income (NOI). This is also used to estimate the investor's potential return on their investment. The cap rate is also an estimate of your cash flow income and, if you made your acquisition in cash, it is your return on investment (ROI). The cap rate is compared against the risk-free rate of return, which is usually defined as the rate of return on the US Treasury note. A lower cap rate should correspond to a lower level of risk, while a higher cap rate should imply more risk in the deal.
The capitalization rate of an investment can be calculated by dividing the property's net operating income (NOI) by the current market value or acquisition cost of a property - expressed in the following formula: Capitalization Rate = Net Operating Income / Current Market Value.
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