Cap Rates Demystified

Clients and students are always fascinated by capitalization rates, or “cap rates”: Why are they different from place to place, property type to property type, and overall building quality reflected by its construction and management. Moreover, what do those cap rates really mean? How should they be interpreted and utilized for investment decision-making or other purposes such as a refinance or tax assessments? In this article, we define and analyze cap rates. We then discuss what is driving cap rates to further explain the observed cap rate differences amongst properties.