Capitalization Rate

Capitalization rate, or cap rate, is a property's net operating income divided by its price. It is the net-income counterpart of gross rent multiplier: GRM divides price by gross rent and ignores expenses, cap rate divides net income by price and includes them. The two are linked through the expense ratio.

Cap rate is approximately (1 minus vacancy) times (1 minus expense ratio) divided by GRM. With 5% vacancy and expenses at 36% of collected rent, cap rate is about 0.61 divided by GRM: a GRM of 10 implies roughly 6.1%, a GRM of 8 roughly 7.6%.

The relationship only holds when the expense ratio is known. Two properties with the same GRM and different expenses, a condo with dues and a house without, have cap rates one to two points apart. That is why GRM is a screen and cap rate is the underwriting number. Screen with GRM, then build the NOI and compute cap rate on the properties that survive.

Further reading: Capitalization Rate on Wikipedia.