Cap Rate
The ratio of a property's net operating income to its market value, used to estimate return potential.
Definition
Capitalization rate (cap rate) is calculated by dividing a property's annual net operating income (NOI) by its current market value or purchase price. A property generating $50,000 NOI and valued at $500,000 has a 10% cap rate. Higher cap rates generally indicate higher potential returns but also higher risk. Cap rates vary significantly by market, property type, and condition. They are most useful for comparing similar properties in the same market. Cap rate does not account for financing, so it measures unlevered return on the asset itself.
How This Relates to DSCR Loans
Cap rate and DSCR are closely related — a higher cap rate property generally produces a stronger DSCR, assuming similar financing terms.
Related Terms
NOI (Net Operating Income)
A property's total income minus operating expenses, before debt service and taxes.
Cash-on-Cash Return
The annual pre-tax cash flow divided by the total cash invested, measuring the return on actual dollars deployed.
Fair Market Value
The price a property would sell for on the open market between a willing buyer and seller.
GRM (Gross Rent Multiplier)
The property price divided by annual gross rent, used as a quick screening tool for investment properties.
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