Capitalization Rate

Capitalization rate, or cap rate, is a property's net operating income divided by its price or value. It measures the property's unleveraged yield before any mortgage. It shares NOI with the commercial DSCR calculation and decides whether borrowing helps or hurts.

A property with $30,000 of NOI priced at $500,000 has a 6% cap rate. Cap rate ignores financing, which is what makes it useful for comparing properties and for valuing income: NOI divided by the market cap rate gives value.

The link to DSCR runs through the loan constant, a year of payments divided by the loan balance. At 7.5% over 30 years the constant is about 8.4%. When the cap rate is above the constant, NOI covers debt service with room and DSCR is comfortable. When it is below, coverage is thin and more leverage makes it thinner. A property at a 6% cap rate needs a large down payment to reach a 1.25 DSCR at today's rates.

Further reading: Capitalization Rate on Wikipedia.