What does the capitalization rate measure in real estate?

The capitalization rate, often referred to as the "cap rate," is a fundamental concept in real estate that measures the potential return on investment of a property. It is calculated by dividing the net operating income (NOI) of a property by its current market value (or purchase price). This figure helps investors assess how well a property can generate income relative to its price, providing insight into the investment's profitability.

When using the cap rate, a higher rate typically indicates a greater potential return, which may attract investors looking for better yield opportunities or suggest a higher level of risk associated with the investment. Conversely, a lower cap rate generally denotes a lower return, which could imply that the property is in a more stable market or has lower associated risks.

Understanding the cap rate is essential for investors when comparing different properties or gauging the performance of real estate investments over time. It provides a straightforward way to evaluate and compare the profitability of various properties regardless of their location or type.

The other options do not accurately define the cap rate's purpose. While the net income generated by a property (as stated in one of the choices) is a component of the cap rate calculation, the cap rate itself focuses on the ratio of net income to property value,