Cap rate explained
What is a cap rate?
A cap rate — short for capitalization rate — is a property's annual net operating income (NOI) divided by its acquisition basis, expressed as a percentage. It is the unleveraged yield a rental property produces before mortgage payments and income taxes.
In real estate, the cap rate helps investors compare properties on operating performance instead of financing. If a rental produces $18,624 of NOI and costs $300,000, the cap rate calculation is 6.21%. The number is a snapshot of price versus income, not a promise of total return.
The short version
- Cap rate = NOI ÷ acquisition basis × 100.
- Mortgage payments, income taxes, and depreciation are excluded.
- A higher cap rate can mean higher yield or higher risk, so compare like-for-like deals.
What is cap rate in real estate?
In real estate, cap rate is both a pricing measure and a risk signal. A lower cap rate means a buyer is paying more for each dollar of NOI, often in a market with strong demand, low vacancy, or expectations of rent growth. A higher cap rate means less upfront price per dollar of income, which can reflect a weaker market, an older property, deferred maintenance, or less reliable income.
That is why an 8% cap rate is not automatically better than a 5% cap rate. The right comparison uses similar property types, locations, lease terms, and expense assumptions. Local vacancy, taxes, insurance, condition, and buyer demand all influence the going-in cap rate.
Use cap rate to screen and compare, then pair it with cash flow, cash-on-cash return, DSCR, and a downside rent scenario before you make an offer.
Cap rate formula
The cap rate formula is simple:
Cap rate formula
Cap rate = NOI ÷ acquisition basis × 100
NOI is annual effective gross income minus operating expenses. Effective gross income starts with gross scheduled income, then subtracts vacancy and credit loss. Operating expenses include property taxes, insurance, management, maintenance, repairs, HOA dues, owner-paid utilities, and other costs required to operate the property.
The acquisition basis is usually the purchase price. An all-in basis adds closing costs and immediate rehab, showing the yield on the total capital committed. The calculator supports both; keep the convention consistent when you compare deals.
The calculator also lets you include a capex percentage and annual reserves. Some traditional cap rate calculations exclude capital reserves, so disclose the choice. A cap rate built with reserves and one built without are not directly comparable.
For a full walkthrough of NOI, expense treatment, and reverse cap rate, read the cap rate formula guide.
How to calculate cap rate
To calculate cap rate, follow the same five steps:
- 01Annualize market rent and other income to get gross scheduled income.
- 02Subtract vacancy and credit loss to get effective gross income.
- 03Subtract operating expenses to get NOI. Do not subtract mortgage principal or interest.
- 04Choose the acquisition basis: purchase price for a market cap rate, or price plus closing costs and rehab for an all-in cap rate.
- 05Divide NOI by the basis and multiply by 100 to express the result as a percentage.
Small assumptions matter. A 1% change in vacancy or a missing insurance line can move the cap rate enough to change how a deal ranks.
Cap rate calculation example
Using the calculator's default deal, the property generates $31,200 of gross scheduled income. A 5% vacancy allowance removes $1,560, and $11,016 of operating expenses leaves $18,624 of NOI. On a $300,000 purchase price, that is a 6.21% cap rate.
Example deal
- Gross scheduled income
- $31,200
- Vacancy loss
- −$1,560
- Operating expenses
- −$11,016
- Net operating income
- $18,624
- Acquisition basis
- $300,000
- Cap rate
- 6.21%
Reverse the formula to estimate value at a target cap rate. The same $18,624 of NOI supports the following values:
| Target cap rate | Implied value |
|---|---|
| 5% | $372,480 |
| 6% | $310,400 |
| 7% | $266,057 |
| 8% | $232,800 |
The calculator also solves for the monthly rent needed to hit a target cap rate after vacancy and percentage expenses, which is useful when you are testing a purchase price against market rent.
What is a good cap rate?
There is no universal good cap rate. A good cap rate depends on the market, property type, condition, income quality, and the return you require. A 5% cap rate may be reasonable in a low-vacancy market with strong rent growth; an 8% cap rate may be normal where vacancy is higher, buildings are older, or buyers demand more compensation for risk.
A high cap rate is not automatically a bargain. It can reflect deferred maintenance, unrealistic rent, rising insurance, or a market with fewer buyers. A low cap rate is not automatically safe either; it leaves less room for error if income disappoints.
Compare the result with local closed sales and stress-test the assumptions. The guide to what is a good cap rate covers property types, markets, and the traps in a pro forma NOI.
How to use this cap rate calculator
Use this cap rate calculator by entering the purchase price, rent, vacancy, and operating expenses. Switch to an all-in basis if you want closing costs and immediate rehab in the denominator. Set a target cap rate to see the implied value, value gap, and monthly rent needed.
The calculator updates in real time and runs in your browser. You can save deals, compare two scenarios, export a CSV, or share a link with the full deal state encoded in the URL. Nothing is sent to a server.
Use the cash flow calculator to add the mortgage and reserves, or the cash-on-cash calculator to measure the return on the cash you invest.
Cap rate in real estate: limitations and common mistakes
Cap rate real estate analysis is useful, but it is not a complete return measure. It excludes mortgage leverage, income taxes, depreciation, appreciation, and sale proceeds. Two properties with the same cap rate can produce very different cash-on-cash returns after financing.
The most common mistakes are using optimistic pro forma rent, leaving out real expenses, mixing purchase price and all-in basis, and comparing cap rates across different property types or markets. A cap rate is only as reliable as the NOI behind it.
Use cap rate as a starting filter, then model the debt and cash flow. The cap rate vs. cash-on-cash return guide shows how financing changes the picture. The methodology explains the conventions behind every output.