What Is Cap Rate?
Capitalization rate (cap rate) measures the unleveraged annual return on a property. It is calculated as Net Operating Income divided by the property's purchase price or market value. Because it ignores financing, cap rate isolates the property's intrinsic income performance — making it useful for apples-to-apples comparison across deals.
When Cap Rate Matters
Cap rate is most relevant for commercial properties and multi-family deals where income is the primary driver of value. For single-family rentals in appreciating markets, cap rate alone understates total return because it excludes leverage, principal paydown, and appreciation.
Reading Market Cap Rates
Class-A urban properties typically trade at 4–6% cap rates. Class-B suburban properties trade at 6–8%. Class-C and tertiary-market properties can exceed 9% but carry meaningfully higher operational risk. A cap rate that looks 'too high' usually reflects something — deferred maintenance, tenant quality, or location risk.
Common Pitfalls
Sellers often advertise pro-forma cap rates that assume rent increases or expense reductions that have not yet occurred. Always recalculate cap rate from actual trailing 12-month financials, and verify property taxes will reset to your purchase price (not the seller's basis).