Rack-Rent

Rack-rent is the full market rent a property can command. A property is rack-rented when the rent the tenant currently pays, the passing rent, equals its estimated rental value. In that case the initial yield and the reversionary yield are the same, and the cap rate reflects the property's true income.

When passing rent is below market, the cap rate computed on it understates the property. A lease at $3,600 on a unit worth $4,000 shows a 5.0% cap rate on a $500,000 price where the rack-rented figure would be 5.8%. Buyers pay for that reversion, which is why below-market leases with near-term resets attract lower cap rates on passing rent.

When passing rent is above market, the opposite holds and the cap rate flatters the property until the lease resets. Appraisers handle this by computing NOI on market rent and adjusting for the lease; the UK yield tradition handles it by quoting initial and reversionary yields separately. Either way, ask whether the rent behind a cap rate is the rent the property will actually earn.

Further reading: Rack-Rent on Wikipedia.