Investment Metrics
Cap Rate Calculator: Formula, Worked Example and What Counts as Good
The return a property earns on its own, before your loan gets involved, and how to read it without being fooled by it.
Capitalization rate is the most quoted number in rental investing and one of the most misread. It measures a property's earning power independent of how anyone pays for it. This guide covers the formula, a full step-by-step example, what makes a cap rate good, how it compares with cash-on-cash return, and the four situations where it is the right metric to reach for.
What cap rate measures
Cap rate is a property's annual net operating income divided by its price or value. It answers: if I paid cash for this property, what percentage of that cash would it return each year before income tax, appreciation and loan effects.
Cap rate = (Net operating income ÷ Property value) × 100
Net operating income is annual rent minus vacancy and every operating expense. The mortgage is not an operating expense.
Because financing is left out, the number belongs to the property rather than to the buyer. Two investors with different down payments and rates get the same cap rate on the same house, which is exactly what makes it useful for comparison.
How to calculate net operating income
NOI is where cap rate calculations go wrong, usually by leaving expenses out. Start from gross scheduled rent, subtract vacancy, then subtract every cost of operating the property.
| Include | Exclude |
|---|---|
| Property taxes | Mortgage principal and interest |
| Insurance | Depreciation |
| Property management | Income taxes |
| Maintenance and repairs | Capital improvements that add value (budget a reserve instead) |
| Vacancy and collection loss | Your own labor, unless you would otherwise pay for it |
| HOA dues, utilities you pay, landscaping, pest control |
Operating expenses typically run 35% to 50% of gross rent for single-family rentals, higher for older buildings and high-tax states.
A step-by-step cap rate calculation
A three-bedroom single-family rental in a suburban market, priced at $300,000 and renting for $2,800 a month. Taxes of $3,600 a year, insurance $1,400, management at 10% of rent, maintenance and vacancy at 5% each, and an HOA of $60 a month.
Net operating income and cap rate on a $300,000 rental
- Annual gross rent$2,800 × 12
- $33,600
- Property taxes
- −$3,600
- Insurance
- −$1,400
- Property management (10%)
- −$3,360
- Maintenance (5%)
- −$1,680
- Vacancy (5%)
- −$1,680
- HOA dues
- −$720
- Net operating income$33,600 − $12,440 of expenses (37% of rent)
- $21,160
- Cap rate$21,160 ÷ $300,000
- 7.05%
What counts as a good cap rate
A good cap rate is above the typical rate for comparable properties in the same market, without a risk the higher rate is paying you to accept. Markets price risk into cap rates the way bond markets price it into yields.
| Market type | Typical cap rate | What you are buying |
|---|---|---|
| Gateway cities (New York, San Francisco, Los Angeles) | 3% to 5% | Appreciation and liquidity; thin or negative cash flow |
| Growth metros (Austin, Nashville, Denver, Tampa) | 5% to 7% | Balanced returns with population-driven demand |
| Stable secondary markets (Indianapolis, Kansas City, Columbus) | 7% to 9% | Cash flow with moderate appreciation |
| Tertiary and higher-risk markets | 9% to 12% or more | High cash flow, weaker liquidity, more management |
Illustrative ranges. Class A properties trade at the low end of each range, Class C at the high end.
Cap rate vs cash-on-cash return
Cap rate judges the property. Cash-on-cash return judges your deal, financing included. Both matter, and on the same property they can point in different directions.
| Cap rate | Cash-on-cash return | |
|---|---|---|
| Formula | NOI ÷ property value | Annual cash flow after debt ÷ cash invested |
| Includes financing | No | Yes |
| Best for | Comparing properties and markets, valuation | Judging your leveraged return |
| Changes with your down payment | No | Yes |
Finance the example above with 20% down and a 30-year loan at 6.75%. The cap rate stays at 7.05%; the cash-on-cash return does not.
The same $300,000 property, financed
- Net operating income
- $21,160
- Annual debt service$1,557 a month
- −$18,684
- Annual cash flow
- $2,476
- Cash-on-cash return$2,476 ÷ $66,000 invested
- 3.8%
Read side by side, the two numbers tell you whether the property is priced fairly and whether your financing makes sense. A property page that shows cash flow, cap rate, cash-on-cash and ROI together saves the reconciliation.
Example uses public listing data for illustration. See disclaimer.
When cap rate is the right tool
Comparing properties at different prices
A $200,000 duplex and a $500,000 fourplex cannot be compared on cash flow, but they can on cap rate. Rank candidates within the same market by cap rate, then check what explains the outliers.Valuing a property from its income
Value = NOI ÷ market cap rate. $20,000 of NOI at a 7% market cap rate supports a price of about $285,700. The same arithmetic prices an improvement: raise NOI by $5,000 and you have added roughly $71,400 of value at 7%.Reading a market
Falling cap rates mean buyers are paying more for each dollar of income, which is confidence or froth. Rising cap rates mean the reverse. Compare a listing's rate with recent sales to see which way its market is moving.Judging an all-cash purchase or an exit
For a cash buyer, cap rate is the return. For a seller, projected NOI times the market cap rate at exit is the sale price the projection depends on.
Sorting an entire ZIP code by cap rate turns the comparison from a spreadsheet exercise into a glance.
Example uses public listing data for illustration. See disclaimer.
Cap rate is one of three numbers a decision rests on, beside cash-on-cash return and monthly cash flow. Use it to judge the property and the price. Use the other two to judge the deal.
Frequently asked questions
What is a good cap rate for a rental property?
It depends on the market and the risk. Gateway cities trade at 3% to 5%, growth metros at 5% to 7%, stable secondary markets at 7% to 9%, and smaller or riskier markets at 9% to 12%. A good cap rate is one above the typical rate for comparable properties in the same area, earned without taking on risk the number is compensating you for.
Does cap rate include the mortgage?
No. Cap rate divides net operating income by price, and net operating income excludes debt service. That is deliberate: it measures the property, not your financing. Cash-on-cash return is the metric that includes the mortgage.
How do I calculate net operating income?
Start with annual gross rent, subtract vacancy, then subtract every operating expense: property taxes, insurance, management, maintenance, HOA dues, utilities you pay and a reserve for capital items. Leave out the mortgage, depreciation and income taxes.
Is a higher cap rate always better?
No. A high cap rate is the market pricing in risk: a weaker location, an older building, a thinner tenant pool or a declining area. A 12% cap rate with 20% vacancy can earn less than a 6% cap rate that stays full. Read the rate together with the reasons behind it.
Can I use cap rate to value a property?
Yes. Value = NOI ÷ market cap rate. A property earning $20,000 of net operating income in a market where comparable rentals trade at a 7% cap rate is worth about $285,700. The same formula shows what a $5,000 increase in NOI adds to value: about $71,400 at 7%.
Keep reading
Cash Flow vs Cap Rate
When each metric misleads, and how to use them together.
Read articleHow to Calculate Cash-on-Cash Return
The metric that adds your financing back in.
Read articleGross Rent Multiplier (GRM)
The quicker screen that comes before cap rate.
Read articleRental Income Calculator
Projecting the rent and expenses that feed net operating income.
Read articleGet the cap rate on any address in a minute
Smart Rental Investor estimates rent from nearby comparables, fills in every operating expense line, and reports cap rate, cash flow and cash-on-cash return for the property. Edit any expense and the cap rate updates.
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