In discussions of real estate investments, the term “cap rate” (for capitalization rate) is commonly used. A cap rate is a property’s expected net operating income (NOI), expressed as a percentage of a buyer’s investment, assuming an all-cash purchase.
Suppose, for example, a shopping center is projected to have $1 million in NOI this year. If that center is bought for $5 million, the cap rate would be 20: $1 million is 20 percent of $5 million. If the purchase price is $20 million, the cap rate would be 5. Thus, a low cap rate indicates a high selling price.
Today, cap rates might vary from 6 to 10, depending on factors such as the credit quality of the tenants, the length of existing leases, and so on. If you are making a real estate investment, look for cap rates that are over 8, and thus in the upper half of that range.
