What is cap rate?
Cap rate (short for capitalization rate) is the unleveraged return a property generates as a percentage of its purchase price. It strips out financing entirely so you can compare two properties on equal footing — regardless of whether one buyer plans to put 25% down at 7% and another plans to pay cash.
The formula
How to compute NOI
Net Operating Income is the annual cash the property generates from rent before debt service and before income tax. The formula:
NOI = Annual rent − Annual operating expenses
Operating expenses include:
- Property taxes
- Insurance
- HOA fees (if any)
- Owner-paid utilities
- Property management fees
- Maintenance reserve (commonly 5–10% of rent)
- Vacancy reserve (commonly 5–8% of rent)
- Capital expenditure reserve (commonly 5–10% of rent)
They do notinclude mortgage principal or interest, depreciation, or income taxes — those affect your personal returns, not the property's operating economics.
What's a good cap rate?
Cap rate isn't good or bad in isolation — it's good or bad relative to your market and risk tolerance. The general benchmarks:
| Range | Profile | Typical markets |
|---|---|---|
| 4–6% | Appreciation play, low cash flow | SF, LA, Seattle, NYC, Boston |
| 6–8% | Healthy cash flow, stable demand | Most Midwest + Sun Belt suburbs |
| 8–10% | Cash-flow-heavy, less appreciation | Cleveland, Memphis, Birmingham |
| 10%+ | High risk — verify carefully | Distressed neighborhoods, C-class assets |
A great cap rate in San Francisco might be 5%. A great cap rate in Memphis might be 9%. Use the metric for comparison within a market, not as a universal scoring system.
Cap rate vs. cash-on-cash return vs. ROI
These three metrics answer different questions, and serious investors use all of them:
- Cap rate — How well does the property perform as an asset? Ignores financing.
- Cash-on-cash return — How hard is the cash I actually invested working? Includes the effect of leverage.
- Total ROI / IRR— Including appreciation, tax benefits, and principal paydown, what's the full annualized return across the hold period?
Cap rate is the only one of the three that's independent of you as the buyer. Two buyers can produce wildly different cash-on-cash returns on the same property by changing the down payment, but the cap rate stays the same.
Common mistakes investors make with cap rate
1. Using gross rent instead of NOI
Plenty of online listings advertise “9% cap rate” using gross rent over price. That's not the cap rate — that's the gross rent multiplier inverted. Real cap rate subtracts operating expenses first. Always recompute.
2. Forgetting vacancy and CapEx reserves
A property doesn't actually generate 100% of its asking rent. Vacancies happen. Roofs need replacing. The cap rate that ignores 5–10% vacancy and 5–10% CapEx reserves is a fiction.
3. Comparing across markets
An 8% cap rate doesn't mean the same thing in Cleveland and Phoenix. Compare within markets, not across them.
4. Ignoring asset class
A-class properties in the same zip code trade at lower cap rates than C-class properties. The difference is risk and vacancy exposure, not opportunity.
When to use this calculator
Cap rate is the first filter on any deal. Investors who underwrite well will run cap rate on every property they consider — often within 60 seconds of seeing the listing — and only proceed to a full analysis on the ones that clear their hurdle. This calculator gives you that 60-second answer.
When you're ready to go deeper — cash-on-cash, DSCR, monthly cash flow, 10-year projections, tax strategy, exit scenarios, and a deal score — you can run the full analysis free at TrueCap.
Frequently asked questions
What is cap rate?+
Cap rate (capitalization rate) is the unleveraged annual return a property generates as a percentage of its purchase price. It equals Net Operating Income divided by property value. Because it ignores financing, it's the cleanest way to compare two properties' raw earning power, regardless of how each buyer might finance the deal.
What's a good cap rate for a rental property?+
It depends on the market. In Tier 1 / coastal markets like San Francisco, Seattle, and New York, cap rates often sit between 4–6% because investors expect appreciation. In stable Midwestern and Southern markets, 6–8% is healthy. Cash-flow-heavy markets and lower-cost cities can push 8–10%. Anything above 10% should be verified — a high cap rate often signals either great cash flow or hidden risk (deferred maintenance, problem area, optimistic rents).
What's the difference between cap rate and cash-on-cash return?+
Cap rate ignores financing. It tells you how the property performs as an asset, regardless of how it's bought. Cash-on-cash return divides your annual cash flow (after debt service) by the actual cash you put in (down payment + closing costs). It tells you how hard your money is working. Both matter — cap rate for comparing properties, cash-on-cash for comparing your investment to alternatives.
Does cap rate include the mortgage payment?+
No. That's the defining feature of cap rate. Net Operating Income excludes principal and interest, so cap rate measures the property's economics independent of how it's financed. This is also why cap rate doesn't change when interest rates move — only NOI and market value do.
How do I calculate NOI?+
Start with annual gross rental income, then subtract all operating expenses: property tax, insurance, HOA, utilities (if owner-paid), management, vacancy reserves, maintenance reserves, and CapEx reserves. Do not subtract mortgage payment, depreciation, or income tax. The result is NOI.
Is a higher cap rate always better?+
No. Higher cap rates price in higher risk. A 12% cap rate in a stable suburban market might signal an underestimated capex backlog, rents above market, or a neighborhood with declining demand. Always cross-check with rent comps, recent capex history, and local vacancy data before celebrating a high cap rate.
Why do experienced investors care so much about cap rate?+
It's the apples-to-apples comparison metric. Two properties at $300k each — one at 5% cap, one at 8% cap — are not equivalent investments even if their gross rent is the same. Cap rate makes the difference visible. It's also the metric commercial lenders quote when comparing properties for refinance and appraisal.