The formula
Cap rate = NOI ÷ purchase price. A property with $120,000 NOI priced at $1,600,000 has a 7.5% cap rate. Rearranged, value = NOI ÷ cap rate.
What it tells you
Cap rate is the unleveraged annual return on the price, and a shorthand for how the market prices risk. Lower cap rates usually mean newer properties, stronger locations or more stable income; higher cap rates mean more perceived risk.
Common mistakes
Using the seller's NOI without adjusting taxes, insurance and management. Comparing cap rates on different kinds of NOI (actual vs pro forma). Ignoring upcoming capital needs that a cap rate doesn't capture.
This guide is general information, not legal, tax or financial advice. Talk to your own advisors about your situation.
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