What is a capitalization rate?
A capitalization rate (cap rate) is the percentage return an investor can expect from a rental property based on its net operating income divided by its purchase price. It helps compare investment properties across different markets.
What is a good capitalization rate?
A good cap rate typically ranges from 4% to 12%, depending on location, property type, and market conditions. Higher-risk properties may offer rates above 12%, while stable urban properties often range from 4% to 8%.
Is a higher capitalization rate better?
Generally yes—a higher cap rate indicates a stronger return on investment. However, higher cap rates often come with higher risk, so compare similar properties in the same market to assess whether the return justifies the risk.
Can capitalization rate be negative?
Yes, a cap rate is negative when a property's net operating income is negative—meaning operating expenses exceed rental income. This indicates the property loses money and requires changes to become viable.
What is the difference between cap rate and cash-on-cash return?
Cap rate uses the full property purchase price in its calculation, while cash-on-cash return divides annual cash flow by only the actual cash invested (down payment). This makes cash-on-cash return more relevant when financing is involved.