In the context of investment properties, what is capitalization rate?

The capitalization rate, often referred to as the cap rate, is a key metric used in the valuation of investment properties. It represents the rate of return on an investment property based on the income that the property generates, typically expressed as a percentage. Investors use the cap rate to assess the potential return on an investment and to compare the profitability of different real estate opportunities.

When calculating the cap rate, the net operating income (NOI) of the property is divided by the purchase price or current market value. This helps investors understand how well a property is performing relative to its cost. A higher cap rate indicates a potentially higher return on investment but may also imply higher risk, while a lower cap rate suggests a safer investment with lower returns.

Other choices do not accurately define the capitalization rate. The rate of inflation pertains to the general increase in prices and is not specific to property income. The interest rate on loans is related to borrowing costs rather than the evaluation of investment returns. The tax rate applied to rental income is a fiscal element that does not reflect the income-generating potential or the investment value of the property itself.