Two rental properties both earn $12,000 a year, but one costs $200,000 and the other costs $300,000. Which is the better buy? The cap rate answers that in a single percent. It is a property’s yearly net operating income divided by its price, and it lets you compare very different deals on the same simple scale.
Cap rate is a rental property’s net operating income (NOI) divided by its value or price, written as a percent. NOI is all rental income minus all operating expenses, but it leaves out your mortgage and income taxes. Example: $12,000 NOI on a $200,000 property gives a 6% cap rate. A higher cap rate often means a cheaper price and more risk, while a lower one often signals a pricier, steadier property. Cap rate ignores financing on purpose, so it is just one tool, not a full verdict.
What Cap Rate Actually Means
The cap rate, short for capitalization rate, shows the yearly return a property would produce if you paid all cash. It strips away loans and focuses on the property itself.
Think of it as the property’s “plain” earning rate. A 6% cap rate means the property’s operating income equals 6% of its price each year. That figure lets you line up homes, duplexes, and small commercial buildings on one scale.
Because it ignores how you pay, cap rate measures the asset, not the financing. Two buyers can pay very different loan terms for the same building, yet the building still has one cap rate.
The Cap Rate Formula
The math is short and easy to remember. You need only two numbers: yearly net operating income and the property’s value or purchase price.
That is the whole formula. The only tricky part is finding NOI correctly, so we cover that next.
How to Find NOI First
Net operating income is the engine of the cap rate. It is all the money a property brings in, minus all the costs of running it.
Start with gross income, mostly rent plus small extras like parking or laundry. Then subtract every operating expense the property needs to function.
Operating expenses usually include:
- Property taxes and insurance
- Repairs and routine maintenance
- Property management fees
- Utilities the owner pays
- A vacancy allowance for empty months
Two big costs are left out on purpose: your mortgage payment and your income taxes. NOI measures the property, not your loan or your tax bracket, so those belong elsewhere.
A Worked Cap Rate Example
Numbers make this clear. Say a small rental collects $24,000 in rent over a year, with no other income.
Its operating expenses add up to $12,000 for taxes, insurance, repairs, management, and a vacancy allowance. So NOI is $24,000 minus $12,000, which equals $12,000.
The property costs $200,000. Divide NOI by price: $12,000 / $200,000 = 0.06. Multiply by 100, and the cap rate is 6%.
| Step | Figure |
|---|---|
| Gross yearly rent | $24,000 |
| Operating expenses | $12,000 |
| Net operating income (NOI) | $12,000 |
| Property price | $200,000 |
| Cap rate ($12,000 / $200,000 x 100) | 6% |
Notice the mortgage never appeared. Whether you pay cash or borrow most of the price, this property’s cap rate stays 6%.
What Counts as a Good Cap Rate
There is no single “good” number. A cap rate is really a signal about price and risk, so context decides what is good.
As a rule of thumb, a higher cap rate means you pay less per dollar of income, which often comes with more risk. A lower cap rate usually means a pricier, steadier property in a strong location. Safer income tends to cost more, so it earns a lower rate.
So a “good” cap rate is one that fits the risk you accept and the returns in your local market. Compare similar properties nearby, not a national average.
Why Cap Rate Ignores Your Mortgage
This is the most common point of confusion, so it is worth stating plainly. Cap rate leaves out financing by design.
By skipping the loan, cap rate keeps the property’s performance separate from your personal deal. That makes it a clean way to compare buildings, since two investors with different loans still see one cap rate.
But you probably care how the loan affects your actual cash. That is a different question, and a different metric answers it: see Cash-on-Cash Return Explained for the financed view of your return.
What Moves a Cap Rate Up or Down
Since cap rate is NOI divided by price, only those two inputs can change it. That makes the drivers easy to follow.
- Raising rent or trimming expenses lifts NOI, which raises the cap rate at the same price.
- A higher purchase price lowers the cap rate, because you pay more for the same income.
- Rising vacancy or repair costs shrink NOI, which pulls the cap rate down.
This is why small operating changes matter so much. A modest, lasting cut in expenses can noticeably improve a property’s cap rate.
It also explains why sellers and buyers often disagree. A seller may use a rosy NOI, while a careful buyer uses realistic costs and a fair value.
Common Cap Rate Mistakes to Avoid
Cap rate is simple math, so most errors come from sloppy inputs. A few habits keep your number honest.
- Leaving out real costs like vacancy, repairs, or management, which inflates NOI.
- Folding the mortgage into NOI, which breaks the formula entirely.
- Using the asking price instead of a fair market value.
- Comparing cap rates across very different markets or property types.
A clean NOI and a realistic value are everything here. Double-check both before you trust the percent the formula gives you.
Tip: for the value in the formula, use a fair market value or a recent appraisal when you can, not just the listing price. The price a seller wants and what a property is worth are not always the same.
Cap Rate vs Other Return Metrics
Cap rate is one lens among several. Each metric answers a slightly different question, so investors often use a few together.
- Cash-on-cash return shows your return after the mortgage, based on the cash you put in. Learn it in Cash-on-Cash Return Explained.
- Rental yield compares rent to price in a simple percent. See How to Calculate Rental Yield.
- Full deal analysis pulls every number together before you buy. Walk through it in How to Analyze a Rental Property Deal.
To run cap rate and these other numbers on your own property, try the Real Estate ROI Calculator.
Ready to put your own numbers in? Estimate NOI, cap rate, and more in seconds with our Real Estate ROI Calculator. It helps you compare properties side by side before you make an offer.
Frequently Asked Questions About Cap Rate
What Is a Cap Rate in Simple Terms?
A cap rate is a rental property’s yearly net operating income divided by its value or price, shown as a percent. It estimates the return you would earn if you bought the property with all cash. A 6% cap rate means the property’s operating income equals 6% of its price each year.
How Do You Calculate a Cap Rate?
Divide the property’s yearly net operating income (NOI) by its value or purchase price, then multiply by 100. For example, $12,000 NOI on a $200,000 property is $12,000 / $200,000 = 0.06, or a 6% cap rate. The hardest part is finding an accurate NOI first.
What Is Included in Net Operating Income?
NOI is all rental income plus small extras, minus all operating expenses. Operating expenses include property taxes, insurance, repairs, management fees, owner-paid utilities, and a vacancy allowance. NOI leaves out your mortgage payment and your income taxes, because those depend on you, not the property.
What Is a Good Cap Rate?
There is no single good number, because cap rate reflects price and risk. A higher cap rate often means a cheaper price and more risk, while a lower one often means a pricier, steadier property. Compare similar properties in the same local market rather than a national average.
Why Does Cap Rate Ignore the Mortgage?
Cap rate measures the property itself, not how you pay for it. Leaving out the loan lets two investors with different financing compare the same building fairly. If you want the return after your mortgage, use cash-on-cash return, which is built for the financed view.
Is a Higher or Lower Cap Rate Better?
Neither is always better, since it depends on your goals. A higher cap rate can mean stronger income for the price but usually more risk. A lower cap rate often points to a safer, in-demand location. Choose the level of risk and return that fits your plan.
Can I Use Cap Rate to Compare Any Two Properties?
Cap rate works best for comparing similar income properties in the same market. It is less useful across very different property types or regions, where risk and expenses differ widely. Treat it as one signal, then check cash-on-cash return and a full deal analysis before deciding.
Sources
Authoritative Sources Used in This Article
This article is for general education only, not financial or investment advice. Real estate returns depend on price, rent, costs, financing, and local market conditions that vary and change, so run your own numbers and consult a professional. Reviewed for accuracy by Prof. Dr. Khalil Mudassar, PhD. Last updated September 12, 2026.
Author
Shakeel Muzaffar is the Founder and Editor-in-Chief of MultiCalculators.com, bringing over 15 years of experience in digital publishing, product strategy, and online tool development. He leads the platform's editorial vision, ensuring every calculator meets strict standards for accuracy, usability, and real-world value. Shakeel personally oversees content quality, formula verification workflows, and the platform's commitment to publishing tools that are genuinely useful for students, professionals, and everyday users worldwide.
