Cap rate

Capitalization rate — cap rate — is the annual return on a property assuming an all-cash purchase. It excludes financing, so it compares properties rather than deals. It is the primary metric investors use to compare assets across markets.

A property with $60,000 NOI and a $1,000,000 value has a 6% cap rate. At the same NOI, a $750,000 price implies an 8% cap rate.

Cap rate turns a property into a yield you can compare with other yields. It also works backwards: NOI divided by the cap rate the market is paying gives you an indicative value, which is why small changes in NOI move value by a multiple.

Use trailing actual NOI, not a pro forma, and be consistent about what sits in operating expenses. Include management fees even when you self-manage, include a realistic vacancy allowance, and keep capital expenditures out of NOI.

The usual distortion is a flattering NOI: management fee omitted, vacancy assumed at zero, a roof replacement classified as maintenance. Comparing cap rates across markets without accounting for tax and insurance differences is the other one.