Capitalization rates, cap rates for short, are one of the most critical factors when assessing commercial real estate.
The cap rate is the ratio of Net Operating Income (NOI) to asset value. For example a property valued at $1 million that generates an NOI of $100,000 has a 10 percent cap rate.
The ratio is used to measure the expected yields on investment property.
Real estate is no different than other types of investments in that the higher the risk, the higher the return an investor expects to earn. Risk factors include creditworthiness of the tenants, location, and the dynamics of the local real estate market.
In general, lower cap rates indicate less risk on an investment (evidenced by increased demand for that investment) while higher cap rates typically signify a property carries higher risk.