The capitalization rate is the yield a buyer would receive if they paid all cash for a property and collected its operating income for a full year. It expresses what the market is willing to pay for a dollar of NOI in a given neighborhood, asset class, and moment in time.
Lower cap rates mean higher prices relative to income, typically in appreciating markets with institutional competition. Higher cap rates mean cheaper prices relative to income, usually in markets with more operational risk or slower appreciation. Comparing cap rates across dissimilar properties is a quick sanity check on relative pricing.
Because cap rate ignores financing, it lets you compare a property bought all cash to one bought with a loan. That makes it useful for valuation and offer modeling, but cash on cash return is the better number once debt enters the picture.
Example
A property producing $24,000 NOI priced at $300,000 has an 8.0 percent cap rate.