Capitalization Rates: What are they telling you?

The capitalization rate (cap rate) is a measure used in real estate to assess investments by comparing a property's yearly rental income to its current market value. This rate is determined by dividing the property's net operating income (NOI) by its market value, and is presented as a percentage. Cap rates are forward-looking indicators that assist investors in estimating potential returns and evaluating the level of risk associated with a property.

Cap rates can differ widely due to various factors, such as:

• Property category: Multifamily and industrial properties typically exhibit lower cap rates compared to office and retail properties.
• Property condition: Class A properties generally have lower cap rates than Class B or C properties.
• Market dynamics: Commercial properties in major markets usually have lower cap rates than those in secondary and tertiary markets.
• Additional considerations: Interest rates, overall economic conditions, and investor demand can also influence cap rates.

High cap rates usually indicate more risk and conversely low cap rates are usually less risky.