Cap Rate
Cap rate, or capitalization rate, is a property's annual net operating income divided by its price, expressing the unleveraged yield as a percentage.
Definition
The capitalization rate, or cap rate, is a quick measure of a real estate investment's unleveraged return. It is calculated as annual net operating income (NOI) divided by the property's value or purchase price. A property generating $500,000 of NOI and priced at $10 million has a 5% cap rate.
Cap rate lets investors compare properties on an apples-to-apples basis, independent of financing. Lower cap rates generally signal lower perceived risk and higher-quality or higher-growth assets, while higher cap rates imply more risk or less demand. It is an income snapshot, not a total-return figure; it ignores appreciation, debt, and taxes.
For 1031 and DST investors, cap rate helps gauge whether replacement property income is competitive. But it is only a starting point: two properties with the same cap rate can differ widely in tenant quality, lease term, and location. It should be weighed alongside distribution yield and the underlying business plan.
Key points
- Net operating income divided by property value
- Measures unleveraged yield, ignoring financing
- Lower cap rates typically mean lower perceived risk
- A snapshot of income, not total return
Related terms
Jerry Baker founded Baker 1031 Investments to help exchange investors move from active property ownership into passive, institutional-quality real estate through DST, 721 exchange, mineral royalty, and Opportunity Zone strategies. He holds the FINRA Series 22 and Series 63 registrations and the Securities Industry Essentials (SIE) qualification. Read full bio →
Reviewed by the Aurora Securities, Inc. compliance team — Aurora Securities, Inc., member FINRA/SIPC. Last reviewed July 2026. Securities are offered through Aurora Securities, Inc.; Baker 1031 Investments, LLC is independent of Aurora Securities, Inc.
This glossary entry is educational and is not investment, tax, or legal advice, or an offer to sell or a solicitation to buy any security. Definitions are general and may not reflect your specific circumstances — consult your own CPA and attorney. Past performance does not guarantee future results.