The cap rate, short for capitalization rate, is a metric used to estimate and compare the rates of return on multiple commercial or residential real estate properties. It is calculated by dividing a propertys net operating income (NOI) by its asset value. The cap rate is expressed as a percentage and represents the yield of a property over a one-year time horizon assuming the property is purchased on cash and not on loan. A higher cap rate indicates a greater risk and return. However, it should not be used as the sole indicator of an investments strength because it does not take into account leverage, the time value of money, and future cash flows from property improvements, among other factors.

There is no official definition of a good or bad cap rate in real estate because several factors can impact one propertys cap rate compared to another. The ideal cap rate varies from investor to investor and property to property. In general, a cap rate between 5% and 10% is considered good. However, some elements that affect a propertys cap rate are hyper-specific, such as the location of a gas station. Therefore, it is important to use other metrics to determine risk levels and the potential returns of an investment rental property.