How to Calculate Cap Rate for Real Estate
The capitalization rate (cap rate) is one of the most important metrics in real estate investing. It expresses a property's annual income as a percentage of its value, letting you compare properties regardless of size or price.
The Formula
Cap Rate = Net Operating Income (NOI) / Property Value × 100%
Calculating Net Operating Income (NOI)
NOI = Gross Rental Income − Vacancy − Operating Expenses
Operating expenses include: property taxes, insurance, repairs, property management fees, utilities (if landlord-paid), and reserves. NOI does NOT include mortgage payments—cap rate is a property metric, independent of financing.
Step-by-Step Example
Property purchase price: $500,000 Annual gross rent: $48,000 (12 × $4,000/month) Vacancy (7%): $3,360 Operating expenses: $14,000
- NOI = $48,000 − $3,360 − $14,000 = $30,640
- Cap Rate = $30,640 / $500,000 × 100% = 6.13%
What Cap Rate to Aim For
| Cap Rate | Interpretation |
|---|---|
| < 4% | Low risk, low return (prime urban markets) |
| 4–6% | Moderate (suburban/stable markets) |
| 6–8% | Good return (typical investment target) |
| > 8% | Higher return but higher risk |
Limitations of Cap Rate
Cap rate doesn't account for: financing terms, appreciation potential, tax benefits, or capital expenditures. Use it alongside cash-on-cash return and GRM for a complete picture.
Use our cap rate calculator to analyze any income property.