How to calculate cap rate
The capitalization rate is the yearly return a property would produce if you bought it with cash. It lets you compare properties without the effect of financing.
Cap rate = net operating income ÷ property value × 100
Worked example
A rental priced at $400,000 collects $36,000 a year in rent and has $12,000 in operating expenses. After a $1,800 vacancy allowance, net operating income is $36,000 − $1,800 − $12,000 = $22,200. $22,200 ÷ $400,000 = 5.55% cap rate.
What counts in net operating income
Start with gross rent, subtract an allowance for vacancy, then subtract operating expenses: property tax, insurance, repairs, management, and utilities the owner pays. Do not subtract mortgage payments, depreciation or income tax. Use the NOI calculator to build the number.
Using cap rate to value a property
Rearranged, the formula gives a value: value = NOI ÷ cap rate. If similar buildings sell at a 6% cap rate, a property with $30,000 of NOI is worth about $500,000.
How to use this calculator
Enter the property value, the gross income, the vacancy and the operating expenses. The cap rate calculator works out net operating income from those, divides it by the value and shows the cap rate as a percentage. It also shows what the property would be worth at a 6% and an 8% cap rate. Use a full year of income and expenses, not one good month multiplied by 12.
What the result means
A 5.55% cap rate means the property earns $5.55 of net operating income a year for every $100 of price, before any loan. The number is only useful next to other numbers. Compare it with the cap rates of similar properties in the same area, and with what the same money could earn elsewhere.
More examples
Price and cap rate move in opposite directions. Here is the same $22,200 of NOI at three prices.
| Price | NOI | Cap rate |
|---|---|---|
| $370,000 | $22,200 | 6.00% |
| $400,000 | $22,200 | 5.55% |
| $444,000 | $22,200 | 5.00% |
The same works in reverse for value. A property with $30,000 of NOI is worth about $600,000 at a 5% cap rate, $500,000 at 6% and $428,571 at 7%.
What changes the result
- Price. A lower price raises the cap rate on the same income.
- Rent and vacancy. More collected rent raises NOI and the cap rate. In the example, leaving out the $1,800 vacancy allowance would show 5.85% instead of 5.55%.
- Operating expenses. Every dollar of expense comes straight out of NOI.
- Small income gains. At a 6% cap rate, an extra $100 a month of NOI ($1,200 a year) supports about $20,000 more value.
Common mistakes
- Subtracting the mortgage payment from NOI.
- Using the seller’s projected rents instead of rents actually collected.
- Leaving out vacancy, management or repairs because you plan to handle them yourself.
- Comparing cap rates across different property types or neighborhoods.
- Treating a high cap rate as a better deal without asking why the price is low.
Related calculators
For a quicker screen that uses rent alone, try the gross rent multiplier calculator. If you plan to borrow, the DSCR calculator checks whether the income covers the loan payments. The rental property calculator puts income, expenses and financing together. Results are estimates.
Frequently asked questions
What is a good cap rate?
It depends on the market and the property type. Lower cap rates usually mean lower risk and higher prices. Higher cap rates usually mean more risk or weaker locations. Compare against similar properties nearby.
Is cap rate the same as ROI?
No. Cap rate ignores financing. Cash on cash return and ROI include your loan. See the cash on cash return calculator.
Does cap rate include the mortgage?
No. Loan payments are left out so that properties can be compared on the same basis.
Is a higher cap rate better?
Not by itself. A higher cap rate means more income for the price, but it often comes with more risk. Look at the condition, location and tenants before you decide.
How is cap rate different from gross rent multiplier?
Gross rent multiplier compares price with rent before expenses. Cap rate uses net operating income, so it accounts for vacancy and operating costs.
Does a property’s cap rate change over time?
Yes. It moves whenever the income or the value changes. A rent increase raises it at the same value. A higher value lowers it at the same income.