Real Estate / Underwriting
Cap Rate (Capitalization Rate)
Definition
Capitalization Rate (Cap Rate) is a valuation metric calculated by dividing a property's Net Operating Income by its purchase price or current market value, expressing the expected annual return on investment before financing costs and representing relative risk and return expectations.
Formula
Cap Rate = (NOI ÷ Purchase Price) × 100
Why It Matters to Hotel Investors
- Quick valuation tool to compare investment opportunities
- Lower cap rates typically indicate higher-quality, lower-risk assets in competitive markets
- Higher cap rates may signal value-add opportunities or higher perceived risk
Common Mistake
Assuming cap rate equals investor return—cap rate only measures NOI yield before debt service, not actual cash-on-cash or total returns.
Related Resources
NOI (Net Operating Income)
Net Operating Income (NOI) represents a property's total income after all operating expenses are deducted but before debt service, taxes, and capital expenditures, serving as the foundational metric for real estate valuation and return calculations.
Understanding Cap Rates
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