What Is Cap Rate?
Capitalization rate, commonly called cap rate, measures a rental property’s annual net operating income relative to its value.
Formula
Cap Rate = Annual NOI ÷ Property Value × 100
Cap Rate Example
If a rental property has $42,000 in annual NOI and a $600,000 property value, the calculation is $42,000 divided by $600,000, or 0.07. The cap rate is 7.0%. In this example, the rental property produces annual NOI equal to 7% of the property value.
How It Works
- Enter annual net operating income and the property value used for the analysis.
- The calculator divides annual NOI by property value and multiplies by 100.
- Because NOI excludes financing costs such as mortgage principal and interest, cap rate focuses on the operating performance of the property rather than the owner’s financing structure.
Why It Is Important
- Cap rate helps compare income-producing properties using a common yield metric.
- It separates property operating performance from loan structure.
- It should be used with cash flow, NOI quality, occupancy, property condition, and local market context rather than by itself.
Important Limits
This calculator is for planning and education. It does not replace accounting, tax, lending, legal, appraisal, or investment advice. Actual performance depends on rent collection, lease terms, repairs, vacancy, financing, taxes, insurance, local market conditions, and the quality of your source records.
What Property Value Should You Use for Cap Rate?
The appropriate value depends on what you are analyzing.
For an existing property, investors often use estimated current market value to understand the property’s current cap rate.
When evaluating a potential acquisition, purchase price or expected acquisition value may be used.
Be consistent when comparing properties. Using purchase price for one property and current market value for another can make comparisons misleading.
What Expenses Are Included in NOI?
Common operating expenses may include property taxes, insurance, repairs, routine maintenance, property management, HOA fees, landlord-paid utilities, landscaping, pest control, and other recurring property operating costs.
Mortgage principal, mortgage interest, depreciation, owner income taxes, and capital expenditures are generally excluded from NOI.
Cap Rate vs. Cash Flow
Cap rate and cash flow answer different questions. A property can have an attractive cap rate but weak owner cash flow if debt service is high.
| Cap Rate | Cash Flow |
|---|---|
| Based on NOI and property value | Based on actual cash inflows and outflows |
| Excludes mortgage payments | Includes debt service when evaluating owner cash flow |
| Useful for comparing properties | Useful for understanding money left to the owner |
| Not affected directly by financing structure | Strongly affected by financing |
Cap Rate vs. Cash-on-Cash Return
Cap rate evaluates property operating income relative to property value.
Cash-on-cash return evaluates annual cash flow relative to the investor’s actual cash invested.
| Cap Rate | Cash-on-Cash Return |
|---|---|
| NOI / property value | Annual cash flow / cash invested |
| Ignores financing structure | Reflects financing |
| Property-level metric | Investor-level return metric |
| Useful for comparing properties | Useful for evaluating invested cash |
Cap Rate vs. ROI
Cap rate measures one year’s property operating income relative to property value.
Return on investment can consider a broader range of returns and investment costs, potentially including cash flow, appreciation, financing, and other factors depending on how ROI is defined.
Related Guides
Rental ROI CalculatorActual vs. Projected Cap Rate
A cap rate is only as reliable as the NOI used in the calculation.
Historical cap rate uses actual operating results. Projected or pro forma cap rate uses assumptions about future rents, vacancy, expenses, or operations.
When reviewing a property listing, determine whether the advertised cap rate is based on actual trailing results or projected performance.
A seller may calculate a future cap rate using expected higher rents or lower expenses that have not yet occurred.
Using T-12 NOI: A trailing-12-month, or T-12, NOI uses income and operating expenses from the most recent 12 months. Using T-12 NOI can provide a more current cap-rate calculation than relying solely on a prior calendar year.
Related Guides
Rental Property NOI GuideWhat Is a Good Cap Rate?
There is no universal "good" cap rate.
Cap rates vary by market, property type, neighborhood, property condition, renter stability, expected growth, and perceived risk.
A 5% cap rate in one market could represent a very different investment from a 7% cap rate in another.
Higher cap rates generally indicate more NOI relative to property value, but higher returns may also be associated with greater risk or weaker growth expectations.
Cap rate is best used as one comparison metric rather than as a pass/fail investment rule.