In one sentence
Net operating income divided by property value, the market's shorthand for pricing income-producing real estate.
The longer version
A property producing $700K of NOI valued at a 7% cap rate is worth $10M. Cap rates move with interest rates, property type, market, and asset quality, and small cap rate moves swing values hard: the same NOI at 6% is worth $11.7M.
For lenders the cap rate is an input to check, not a given. Appraisal review asks where the rate came from and whether the comparable sales actually compare.
Common questions
- How do you calculate a cap rate?
- Divide net operating income by property value. A property producing $500,000 of NOI and valued at $10,000,000 has a 5 percent cap rate.
- What does a cap rate tell you?
- The unlevered return the property's income produces on its value. Lower cap rates mean higher prices for each dollar of income, usually reflecting lower perceived risk or stronger growth.
- Why do lenders care about cap rates?
- Because value, and therefore loan to value, depends on the cap rate applied to NOI. Lenders often test value at a higher cap rate than the appraisal uses, especially for refinance risk at maturity.
Keep reading
- The CRE due diligence checklistEvery phase of diligence, organized the way deals close.
- What lenders should look for in a due diligence data roomA lender's room is not an M&A room.
- The commercial loan closing timelineThe stages and what sets the pace.
- Cap rate calculatorRun the number on your own deal.