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, calculated by dividing a propertys net operating income (NOI) by its asset value. Cap rates are expressed as percentages, typically ranging from 3% to 20% . A higher cap rate indicates a higher income relative to the property value, but also a higher risk. Cap rates are used to compare the relative value of similar real estate investments in the market.

It is important to note that cap rates have limitations and should not be the sole metric investors rely on. Cap rates do not take mortgage or financing arrangements into consideration, and assume a cash purchase. They are based exclusively on current rents, without considering external factors like leverage, the time value of money, or improvements or renovations.

The most common way to calculate a commercial real estate cap rate is by using the formula: NOI/Current Property Value = Capitalization Rate. To convert this figure to a cap rate, simply multiply by 100.

A good capitalization rate for commercial real estate varies from investor to investor and property to property. In general, the higher the cap rate, the greater the risk and return. Cap rates are influenced by larger economic factors, such as inflation and interest rates.

Overall, cap rates are a useful tool for real estate investors to gauge the risk and potential return of an asset or property. However, they should be used in conjunction with other metrics to make informed investment decisions.