What does the term "capitalization rate" refer to in real estate?

The term "capitalization rate," commonly referred to as the "cap rate," is a financial metric used to evaluate the potential return on investment for income-generating properties. The cap rate is calculated by dividing the property's net operating income (NOI) by its current market value or purchase price. This formula provides investors with a quick way to assess the profitability and risk associated with a particular real estate investment.

By using the capitalization rate, investors can compare the expected return from different properties and make more informed decisions. A higher cap rate generally indicates a potentially higher return on investment, but it can also signify higher risk. This concept is especially relevant in commercial real estate, where properties are valued based on their income potential rather than just their physical characteristics.

The other choices do not accurately define the term: the capitalization rate is not related to property taxes, it applies to both residential and commercial properties, and it isn't used directly for setting rental prices. Hence, the selected answer highlights the cap rate's role as a crucial tool in investment analysis within the real estate market.