The capitalization rate–commonly referred to as the cap rate–is a measure of the return on investment of income-producing property. It's a short-hand method for evaluating a property and comparing one investment versus another. The simplest version of a cap rate formula is the measure of net income after expenses divided by the cost of the property.
An example: A rental duplex generates $2400 per month in rents and has expenses of $800 for a net income of $1600 per month, or $19,200 annually. If the property costs or is valued at $300,000, the cap rate would be $19,200/$300,000 = 6.4%. This is the equivalent of a return on cash, assuming an investor pays all cash for the purchase. More sophisticated cap rate formulas factor the use of debt for the acquisition.