When investing in real estate, the capitalization rate, commonly referred to as “cap rate”, is used to help understand the projected rate of return on an investment property.
Simply put, the cap rate is calculated by dividing the Net Operating Income (“NOI”) of the property by its current market value. The result, expressed as a percentage, is the cap rate.
For example, let’s say you’re looking at a property that has a current market value of $100,000 and brings in $12,000 after all operating expenses. To calculate the cap rate, you would divide the net operating income by the market value: