What does a Cap rate indicate in property valuation?

The cap rate, or capitalization rate, is a key metric used in property valuation, particularly in the context of investment properties. It indicates the potential return on investment for a property based on its income-generating capabilities. Specifically, it measures the relationship between the net operating income (NOI) of a property and its current market value or purchase price.

When the answer identifies the cap rate as indicating the potential cash flow from multiple rental units, it accurately points out that the cap rate provides insight into how much income a property can generate relative to its value. This calculation is often expressed as a percentage and is useful for investors to compare the profitability of different real estate investments.

For example, a property that has a net operating income of $20,000 and is valued at $250,000 would have a cap rate of 8% ($20,000 divided by $250,000). Investors use this percentage to assess the risk and return potential of various properties, making it a critical tool for making informed investment decisions centered on cash flow.

Understanding the cap rate does not directly involve the total area of the property, the historical appreciation of property value, or the total expenses of maintaining the property. Therefore, focusing on the potential cash flow from rental units