How to calculate cap rate (with worked examples) — 2026 guide
Blog · June 7, 2026 · 7 min read
By TrueCap · built by a Philadelphia rental investor
Cap rate = NOI ÷ purchase price. Sounds simple, but it's easy to mix lender-style NOI with investor cash reserves or to skip vacancy. Here's the formula, three worked examples (a full NOI build-up / a broker's inflated cap / a cash purchase), and when cap rate is the wrong metric.
The cap rate formula
Cap rate = Annual NOI ÷ Purchase price
Two inputs. Get either one wrong and the cap rate lies to you. The formula is fine; the discipline is in how you compute NOI.
How to compute NOI correctly (5 steps)
NOI is net operating income — what the property earns after operating expenses but before debt service. Skipping any of the five steps below is a common reason cap rates look better on paper than they perform.
Step 1: Gross potential rent
Monthly market rent × 12. Use the actual lease rent if the property is currently rented; use comparable-property market rent if vacant.
Step 2: Subtract vacancy allowance
Budget an allowance for your local market — for context, the Census Bureau's national rental vacancy rate was 7.3% in the second quarter of 2026. Even in a hot market, factor in turnover periods, the 30 days you might need to refresh between tenants, and a lease that ends mid-month. A property with a 12-year tenant is still going to turn over eventually.
Step 3: Subtract operating expenses
The full list — easy to skip half of these:
- Property taxes (use the current assessment, and check with the local assessor whether a sale triggers a reassessment).
- Insurance (landlord policy, not homeowner's).
- Property management (a percentage of collected rent — get quotes from local managers; include it even if self-managing — your time has a real cost).
- Maintenance reserve (1-1.5% of property value annually).
- Utilities you pay (water, trash, sewer in many areas; everything for multi-family common areas).
- HOA fees, lawn/snow service, pest control.
NOT in operating expenses: mortgage principal, mortgage interest, depreciation, income tax, or the CapEx reserve. Under the lender/appraiser-style convention TrueCap uses, CapEx is a below-NOI capital reserve. Still subtract a realistic reserve (often modeled around 5-10% of rent or from a component schedule) before judging spendable cash flow.
Step 4: Calculate NOI
What's left after step 2 and step 3. This is the property's true earning power.
Step 5: Divide by purchase price
NOI ÷ purchase price = cap rate. Multiply by 100 to express as a percentage.
Worked example #1: the full NOI build-up
$300K single-family in Tier 2 city, asking $300K, rents at $2,400/mo.
- Gross rent: $2,400 × 12 = $28,800
- Vacancy (6%): −$1,728
- Effective gross income: $27,072
- Property tax: −$3,600
- Insurance: −$1,200
- Management (8% of collected rent): −$2,166
- Maintenance (1.2%): −$3,600
- Utilities + HOA: −$600
- NOI: $27,072 − $11,166 = $15,906
- Cap rate: $15,906 ÷ $300,000 = 5.3%
- CapEx reserve (below NOI): −$3,000
- Cash after CapEx, before debt: $12,906
Whether 5.3% is low depends on what similar rentals in this market trade at — compare it with recent local sales before judging the seller's ask. Leverage won't lift the yield either: at an assumed 7% on a 30-year loan, the loan constant (about 7.98%) sits above the 5.3% cap rate, so borrowing lowers the cash-on-cash return instead of raising it.
Worked example #2: the “8% cap” that isn't
Same property, but the broker tells you it's an “8% cap.”
- Gross rent: $28,800
- Property tax: −$3,600
- Insurance: −$1,200
- Broker's “NOI”: $28,800 − $4,800 = $24,000
- Broker's cap rate: $24,000 ÷ $300,000 = 8%
The broker skipped vacancy, management, recurring maintenance, and utilities. The cap rate looks like 8% but the lender-style result is 5.3%. The separate CapEx reserve then reduces pre-debt cash to $12,906. This is a common gap in broker pro formas — be ruthless about adding back every expense before trusting the number.
Worked example #3: cash purchase same property
Cap rate is identical regardless of financing — that's the whole point of using NOI (pre-debt service). A cash buyer of the property in example #1 gets the same 5.3% cap rate as a buyer using 75% leverage. Their cash-on-cash returns are very different; their cap rates are the same.
This is why cap rate is the metric to use when comparing properties, and cash-on-cash is the metric to use when comparing investments (since financing is part of an investment decision but not part of a property's intrinsic yield).
When cap rate is the wrong metric
Cap rate breaks down in three cases:
- Heavy rehab properties. A vacant gut-rehab has $0 NOI today. Cap rate at purchase is 0% regardless of upside. Use yield on cost (stabilized NOI after rehab ÷ all-in cost) instead.
- Short-term rentals. STR “cap rates” reported in listings often use unrealistically high projected revenue. Underwrite STRs on cash flow with full OpEx buildup instead.
- House hacks. When you live in one unit, the “cap rate” calculation is meaningless — use net housing cost vs. renting instead. Full guide here.
Related reading: What is a good cap rate, Cap rate vs cash-on-cash vs DSCR, Cap rate (glossary).
FAQ
What's the cap rate formula in one line?
Cap rate = annual NOI ÷ purchase price (or current market value). NOI means net operating income — gross rents minus all operating expenses (taxes, insurance, maintenance, management, vacancy allowance, utilities you pay), but BEFORE mortgage payment. Mortgage is financing cost, not operating cost — never subtract it from NOI when computing cap rate.
What counts as an operating expense in NOI?
Property taxes, insurance, property management, recurring maintenance, vacancy allowance, owner-paid utilities, HOA fees, and lawn/snow service. Under the lender-style convention TrueCap uses, the CapEx reserve sits below NOI but still reduces cash flow. Mortgage debt service, depreciation, and income tax are also outside NOI.
What's a good cap rate in 2026?
Highly market-dependent. Cap rates vary by metro, neighborhood, property class and condition, so compare a deal against recent sales of similar stabilized rentals in the same market rather than a national rule. As a rule of thumb, a cap rate above 10% often means heavy rehab risk, weak market fundamentals, or unrealistic NOI assumptions, and one below 4% usually means you're paying for appreciation, not yield. There's no universal 'good' cap rate — it depends on what risk and market you're in.
Should I use purchase price or market value in the denominator?
Both are used in different contexts. Cap rate on purchase price is useful for analyzing a specific deal (NOI divided by total cost including rehab is usually called 'yield on cost'); cap rate on current market value is useful for comparing across properties or tracking your portfolio. When commercial appraisers talk about cap rate, they typically mean market-value cap rate. When investors talk about a deal they bought, they usually mean purchase-price cap rate.
Is cap rate higher always better?
No. A 12% cap rate in a market where 7% is normal usually means something is wrong: deferred maintenance, vacancy risk you haven't priced in, neighborhood declining, or overstated rents. A 4% cap rate in a high-growth market where appreciation has averaged 7-9% annually can still make sense if the appreciation you're underwriting is realistic. Cap rate is a starting filter, not a final answer.
What's the difference between cap rate and cash-on-cash return?
Cap rate ignores financing entirely (NOI ÷ price). Cash-on-cash includes the mortgage payment ((NOI − annual debt service − CapEx reserve) ÷ cash invested). So cap rate tells you the property's intrinsic yield, cash-on-cash tells you the return on the dollars you actually put in. A property with a 6% cap rate bought with 75% leverage earns a higher cash-on-cash return than its cap rate only when the loan's annual payment divided by the loan amount (the loan constant) is below 6% — that spread is the 'positive leverage' that makes real estate work. On an amortizing loan the constant runs above the interest rate: a 30-year loan at 5% has a constant of about 6.44%, so at that rate leverage would lower cash-on-cash, not raise it.