Finance and Returns
Capitalization Rate
Net operating income divided by the property value, used to compare investment properties.
The capitalization rate (cap rate) is a property valuation metric used to compare the profitability of different real estate investments regardless of financing. It represents the income return on a property as if it were purchased in cash. Formula: NOI / Current Property Value × 100. A higher cap rate indicates a higher potential return but often comes with higher risk.
Related terms
Net Operating Income (NOI)
Total rental income minus operating expenses, before mortgage payments and taxes.
Net Rental Yield
Annual rental income minus all operating expenses, divided by the property value.
Return on Investment (ROI)
Net profit as a percentage of the total amount invested in a property.
Frequently asked questions
- What is a good cap rate for a rental property?
- In US markets, a cap rate of 5 to 8% is considered healthy for residential rentals, while commercial properties in major metros like New York or San Francisco often trade at 3 to 4% due to lower risk premiums. In Dubai, residential cap rates typically range from 5 to 7%. A lower cap rate suggests a premium, lower-risk asset; a higher cap rate suggests higher yield but potentially higher vacancy or maintenance risk.
- How do you calculate cap rate?
- Divide the property's annual net operating income (NOI) by its current market value and multiply by 100. For example, if a property generates AED 80,000 in NOI and is valued at AED 1,500,000, the cap rate is (80,000 / 1,500,000) × 100 = 5.33%. Always use current market value rather than purchase price for an accurate comparison across properties.
- What is the difference between cap rate and ROI?
- Cap rate measures the income return on a property independent of financing, as if bought with 100% cash. ROI measures the total return including the effect of leverage, expenses, and any capital gains. Cap rate is best for comparing properties at the point of acquisition; ROI is more useful for evaluating the ongoing performance of your actual investment.
- Does cap rate include mortgage payments?
- No. Cap rate is calculated using NOI, which excludes mortgage interest and principal repayments. This is intentional because cap rate is meant to reflect the property's income potential independent of how it is financed. Two investors can own identical properties with very different financing structures but the same cap rate, which makes it a fair comparison tool across the market.
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