In short, the cap rate is equivalent to the return on investment you would receive if you were to pay all cash for a property, and therefore, it is our way of making the complexities of property investment more transparent.
By definition, the capitalization rate is a ratio used to estimate the value of income producing properties.
Cap Rate = Net Operating Income / Property Price
For example: Purchase Price: $500,000
Income Per Month: $15,000
Expenses Per Year: $100,000
NOI = Annual Income – Annual Expenses
or (12 x $15,000) – ($100,000) or $80,000
Cap Rate = NOI / Property Price or $80,000 / $500,000 or 16%