In commercial real estate, the capitalization rate, or cap rate, is a formula used to estimate the potential return an investor will make on a property. It is a measure of the yield of a property over one year, expressed as a percentage. The cap rate is calculated by dividing the propertys net operating income (NOI) by its current market value. The resulting figure is an assessment of the yield of a property over one year, assuming the property is purchased on cash and not on loan.

A cap rate is used to gauge the risk and potential return of an asset or property. It is a metric that CRE investors rely on to understand the deals risk profile compared to other similar opportunities. Cap rates are measured as percentages, typically ranging from 3% to 20% . The lower the cap rate, the higher the purchase price, and vice versa.

Cap rates are used to estimate and compare the rates of return on multiple commercial or residential real estate properties. They offer one of the quickest and easiest ways to determine the cash flow potential of a given property so that any investor can have an "apples to apples" comparison of different investment opportunities. However, cap rates are not the sole metric investors should rely on, as they do not take mortgage or financing arrangements into consideration. Instead, they assume a cash purchase and are based exclusively on current rents, without considering external factors like leverage, the time value of money, or improvements or renovations.

In summary, cap rate is a measure of the yield of a property over one year, expressed as a percentage, and is used to gauge the risk and potential return of an asset or property. It is calculated by dividing the propertys net operating income (NOI) by its current market value. Cap rates are used to estimate and compare the rates of return on multiple commercial or residential real estate properties, but they are not the sole metric investors should rely on.