What factor does a higher cap rate indicate regarding a property value?

A higher cap rate indicates a higher risk associated with a property. Cap rate, or capitalization rate, is a measure used to estimate the return on investment for a real estate property. It is calculated by dividing the annual net operating income (NOI) of a property by its current market value or sales price.

When the cap rate is higher, it suggests that the investor requires a greater return on their investment due to the perceived risks involved. These risks could stem from various factors such as a volatile rental market, property condition, location, or tenant stability. Investors often demand higher returns to compensate for these risks, which in turn reflects a lower property value in relation to its income-generating potential.

Conversely, a lower cap rate typically indicates a more stable investment with less perceived risk, often leading to higher property values. Understanding the implications of cap rates helps investors assess the risk-reward profile of potential real estate investments.