Real Estate Thinking

Cap Rate

A cap rate turns an income stream into a price, and reveals the market's verdict on that income's risk and growth. It's the same yield-to-value logic that prices any cash-flow asset.

  • Beginner
  • 10 min total
  • 13 chapters

What decision this helps you make: How to use a cap rate to value an income stream and to read what the market thinks of its risk, in real estate and any income-producing asset.

What this topic is

A cap rate is net operating income divided by value: the unlevered yield on an income property, and the yardstick the market uses to turn income into price (value = NOI ÷ cap rate).

Why it matters

It prices income assets and encodes, in one number, the market's view of the income's risk and growth, and it's the same yield-to-value logic that values any cash-flow business or bond.

Who should learn it

Anyone valuing an income stream: a property, a business, a bond, or any asset that produces cash flow.

What you will understand

  • Cap rate = NOI ÷ value; rearranged, value = NOI ÷ cap rate
  • It's the unlevered yield: the return on the whole asset
  • Low cap rate = high price (safe/growing); high cap rate = low price (risky)
  • A cap rate is a valuation multiple, and it prices any income stream

Prerequisites

Common misconception

"A high cap rate means a better investment." A high cap rate means a cheaper price relative to income, which usually reflects more risk, less growth, or a worse location, not a free lunch. And a low cap rate isn't "bad"; it means the market is paying up for income it sees as safe or growing. A cap rate isn't a quality score. It's the market's pricing of an income stream's risk and growth, and you have to judge whether that pricing is right.