What does "cap rate" measure in real estate?

"Cap rate," short for capitalization rate, is a crucial metric in real estate that specifically measures the rate of return on a real estate investment. It is calculated by dividing the net operating income (NOI) of the property by its current market value or acquisition cost. This relationship helps investors understand the profitability of an investment relative to its price.

The net operating income represents the income generated by the property after all operating expenses are deducted, but before depreciation and financing costs. The cap rate, therefore, provides a straightforward way to evaluate the potential return on investment for residential or commercial properties. A higher cap rate indicates a potentially more profitable investment, while a lower cap rate may suggest a less attractive proposition.

In comparison, other options fail to capture the essence of what cap rate is meant to measure. The first option mentions rental income potential, which does not account for expenses or the property's value; the third option addresses market value trends, which are unrelated to the yield on investment; and the last option, concerning maintenance costs, is not relevant to the calculation of return on investment. Understanding the cap rate is vital for making informed investment decisions in real estate.