What is the formula for calculating the capitalization rate?

The capitalization rate, commonly referred to as the cap rate, is a key metric in real estate investment valuation. It is calculated by taking the net operating income (NOI) of a property and dividing it by the property's current market value. This formula provides a way to assess the potential return on an investment property, allowing investors to understand how well it will generate income relative to its market value.

By using net operating income, which is the income generated from the property after operating expenses are deducted, and dividing that by the market value, you derive a percentage that indicates the return on investment. A higher cap rate often suggests a higher potential return but may also imply higher risk, while a lower cap rate typically indicates a lower return with potentially fewer risks.

Understanding this formula is essential for investors seeking to evaluate different properties and make informed decisions based on their investment strategies and desired risk levels.