what is the capitalization rate 
the capitalization rate also known as cap rate is used in the world of commercial real estate to indicate the rate of return that is expected to be generated on a real estate investment property this measure is computed based on the net income that the property is expected to generate and is calculated by dividing net operating income by property asset value and is expressed as a percentage it is used to estimate the investor s potential return on their investment in the real estate market the figure also helps to determine the exit rate or terminal capitalization rate for a property when it is sold at the end of the projected holding period while the cap rate can be useful for quickly comparing the relative value of similar real estate investments in the market it should not be used as the sole indicator of an investment s strength because it does not take into account leverage the time value of money and future cash flows from property improvements among other factors understanding the capitalization ratethe cap rate is the most popular measure through which real estate investments are assessed for their profitability and return potential the cap rate simply represents the yield of a property over a one year time horizon assuming the property is purchased on cash and not on loan the capitalization rate indicates the property s intrinsic natural and un levered rate of return formula for the capitalization rateseveral versions exist for the computation of the capitalization rate in the most popular formula the capitalization rate of a real estate investment is calculated by dividing the property s net operating income noi by the current market value mathematically capitalization rate net operating income current market value