Capitalization Rate or Cap Rate is a term often thrown around in real estate discussions. Yet many people don't really understand what it means. After all, it can be confused with cash-on-cash returns and the rate of return. When you invest in income-producing property, you are looking for cash flow. You also expect to realize a capital gain, selling the property at some time in the future for a profit. When analyzing investment opportunities, real estate investors evaluate a multitude of different factors.
But a typical investor will be interested in the income that the property can generate now and into the future. That investor is likely to use capitalization of income as one method of estimating value. It is one of the most fundamental concepts in real estate investing and is mostly referred to in calculations as “Cap Rate.” Here's what you need to know about the cap rate, from its definition to methods of calculation.