What does a Cap Rate measure in commercial real estate?

A Cap Rate, or Capitalization Rate, is a crucial financial metric used in commercial real estate to assess the potential return on investment for a property. It is calculated by dividing the property's net operating income (NOI) by its current market value or purchase price. This measure provides investors with a percentage that represents the expected annual return on the investment, allowing for comparisons between different properties or investment opportunities.

Focusing on potential return, the Cap Rate helps investors evaluate whether a property aligns with their investment goals and risk tolerance. A higher Cap Rate may indicate a higher potential return, albeit often correlated with higher risk, whereas a lower Cap Rate typically suggests a lower return and potentially lower risk.

While the other options may seem relevant to real estate investment, they do not specifically define what a Cap Rate measures. Current market value, property appreciation, and average annual income are elements that can influence or be affected by Cap Rates, but they do not capture the essence of what the Cap Rate itself specifically determines.