Cap Rate
Capitalization Rate
What is Cap Rate?
Net Operating Income divided by Property Value, expressed as a percentage. The standard unleveraged-return metric.
Cap rate (short for capitalization rate) measures the unleveraged annual return on a real estate asset. It tells an investor what percentage of the purchase price the property earns each year in net operating income, before financing.
Net Operating Income (NOI) is annual gross rents minus operating expenses — property taxes, insurance, property management, repairs and maintenance, HOA dues, and a vacancy reserve. Critically, NOI is calculated before mortgage payments and income taxes, which is why cap rate is an unleveraged metric.
A higher cap rate generally signals higher yield but often higher risk (older property, weaker market, vacancy concerns). A lower cap rate signals a more competitive, in-demand market where investors accept lower yields in exchange for appreciation potential and stability.
How Cap Rate applies at Total Quality Lending
Total Quality Lending does not underwrite DSCR loans on cap rate — we use DSCR (rents divided by PITIA), which already factors in the specific mortgage payment, taxes, and insurance for the deal. Cap rate is the investor’s tool for comparing properties before financing; DSCR is the lender’s tool for sizing the loan after financing is on the table.
That said, savvy investors should run both numbers. Cap rate tells you whether the property is fundamentally sound at the asking price. DSCR tells you whether the specific financing structure cash-flows. A property can have a strong cap rate and still fail DSCR if leverage is too high, and vice versa.