In real estate investing, people love to throw around fancy terms to make simple concepts sound complex. One of those terms is "cap rate." But at its core, the cap rate is just a quick way to measure a property's return based on its cash flow.

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What Cap Rate Tells You

A high cap rate means higher returns but often comes with more risk. A low cap rate signals lower risk but also lower returns. Cap rate is useful for comparing properties but doesn’t factor in financing, appreciation, or value-add potential.

Breaking It Down

Cap rate, short for capitalization rate, is calculated using this formula:

Cap Rate = (Net Operating Income / Purchase Price) x 100

For example, if a building produces $100,000 in net income and is listed for $1,000,000, the cap rate would be:

Cap Rate = ($100,000 / $1,000,000) x 100 = 10%

The Takeaway

Cap rate is just a fancy way to talk about cash flow. If you’re evaluating properties, don’t get lost in the jargon—focus on the numbers that matter.

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