Cap Rate

Cap rate approximates the expected rate of return if the property were purchased with cash (no financing). A higher cap rate often signals higher potential return with potentially higher risk; lower cap rates typically reflect lower risk and stronger demand fundamentals.

Origin of the Term

The term comes from “capitalization,” the practice of converting an income stream into present value. Over time it became a standard yardstick in real estate for assessing value and investment viability across markets and property types.

Synonyms and Antonyms

Synonyms

• Capitalization Rate
• Cap Rate
• Yield (real estate context)

Antonyms

There is no direct antonym for cap rate, but contrasting outcomes include:

• Net Loss
• Negative Cash Flow

How Cap Rate is Used

Cap rate is a quick, comparable indicator used by investors and managers to screen and value properties in the vacation rental and hotel sectors.

• Investment Evaluation: Compare properties on an unlevered basis to identify attractive income profiles.
• Market Comparison: Normalize returns across locations (beachfront vs. city-center) and asset classes.
• Risk Assessment: Higher cap rates can reflect greater perceived risk, operational intensity, or weaker demand.
• Pricing Strategy: Sellers infer value from NOI and market cap rates; buyers test whether price aligns with income potential.
• Portfolio Management: Balance risk and return across units; track shift in yields as occupancy and ADR evolve.

Examples of Cap Rate in Action

• Urban Hotel: NOI = $1,000,000; Value = $10,000,000 → Cap Rate = 10%.
• Beachfront Rental: NOI = $50,000; Value = $500,000 → Cap Rate = 10% (healthy yield with strong seasonal ADRs).
• Rural Cabin: NOI = $36,000; Value = $300,000 → Cap Rate = 12% (higher return may reflect demand volatility or higher operational effort).

Related Terms

• Net Operating Income (NOI)
• Occupancy Rate
• Average Daily Rate (ADR)
• Revenue Management

Cap rate is a foundational metric for evaluating vacation rentals and hotels. Pair it with cash-on-cash return, IRR, and market benchmarks to form a complete, decision-ready view of risk and return.

Frequently Asked Questions

What is the formula for cap rate?

Cap Rate = Annual NOI ÷ Property Value. Express the result as a percentage for quick comparison across properties.

Is a higher cap rate always better?

Not always. Higher cap rates can mean more return and more risk (location, condition, volatility). Balance cap rate with occupancy stability, expense profile, and long-term demand.

How does financing affect cap rate?

It doesn’t—cap rate is unlevered. Financing impacts cash-on-cash return and IRR. Use cap rate for property-to-property comparisons, then layer in your loan terms to assess actual equity returns.

Which expenses go into NOI for cap rate?

Operating expenses only: cleaning and linens, utilities (if owner-paid), maintenance, management fees, insurance, and property taxes. Exclude mortgage payments, income taxes, depreciation, and capital expenditures.

How can I improve a property’s cap rate?

• Lift income with better pricing, LOS optimization, merchandising, and amenity upgrades that raise ADR.
• Trim avoidable costs via vendor bids, energy efficiency, and smart staffing.
• Reassess value periodically; if NOI grows faster than value, your cap rate rises.