Cap Rate Explained: How to Measure a Property's Return

Cap rate measures a real estate investment's return independent of how it's financed: net operating income divided by current property value.

Why it matters

Cap rate is a real estate investing metric, not a business valuation metric — don't confuse it with the multiples used to value a business's cash flow (SDE or EBITDA multiples). Where it does show up in a business sale: if the deal includes the building the business operates from, a buyer or their lender may look at the real estate's cap rate separately from the business's earnings multiple, especially if the real estate and the operating business could plausibly be valued or sold apart. Knowing the difference keeps a seller from accidentally applying a real estate mental model to what is fundamentally a business valuation question, or vice versa.

Example

A property now worth $250,000, generating $30,000 in income against $10,000 in operating costs over the past year, has a cap rate of 12.5% ($20,000 ÷ $250,000).

Net operating income excludes interest, taxes, depreciation, amortization, principal payments, and capital improvements — so cap rate isolates the property's operating performance, not the owner's financing choices.

Related terms: Gross Rent Multiplier (GRM), 1031 Exchange