"Cap Rate" is a term constantly used in commercial real estate investing. Those not in the trenches often don't know what a "cap rate is" and may not want to ask for fear of asking a "stupid question" (there is no such thing!) Here is the short version...
"Cap Rate" or "Capitalization Rate" is simply a way to measure and compare the investment returns from investment properties. Mathematically, it is Gross Revenue from the property minus Operating Expenses (which equals Net Operating Income) divided by the value or price of the property. For example:
Gross Revenue (rent etc) = $150,000
Operating Costs (taxes, insurance, maintenance, etc) = $50,000
Net Operating Income = $100,000
If the value or purchase price is $1,000,000 then the cap rate is 10% ($100,000 / $1,000,000) i.e. the property produces a 10% return before debt service and management expenses.
Changing the algebra, you can determine what the property is worth if you want it to generate a 12% return or "cap rate:" $833,333 ($100,000 / .12)
This measure, without consideration for debt or management expenses which are unique to each owner, allows for a standardized measure to compare the returns generated by various properties. It really is as simple as ABC.
