Cap Rate Calculator

What Is Cap Rate? The Core Concept

Capitalization rate — universally called "cap rate" — is the most fundamental metric in real estate investment. It measures the return a property generates on its value, independent of how it's financed. That last part is critical: cap rate ignores your mortgage, down payment, and financing costs. It's a pure property metric.

The formula is elegantly simple:

Cap Rate = Net Operating Income (NOI) ÷ Property Value × 100

Where:

• NOI = Annual Gross Rent − Vacancy Loss − Operating Expenses (but NOT mortgage payments)
• Property Value = Current market value or purchase price

Using our defaults: $2,200/month rent × 12 = $26,400 gross annual rent. Minus 5% vacancy ($1,320) = $25,080 effective gross income. Minus $6,000 operating expenses = $19,080 NOI. Divided by $300,000 property value = 6.36% cap rate.

This tells you: if you paid all cash for this property, you'd earn 6.36% annually on your investment before appreciation or taxes.

What Is a Good Cap Rate?

There's no universal "good" cap rate — context is everything. Cap rates vary enormously by market, property type, and risk level. The relationship is this: higher cap rate = higher risk or lower-desirability market; lower cap rate = lower risk or high-demand market.

By market type:

• Tier 1 markets (New York, San Francisco, Los Angeles): 3–4% cap rates. Investors accept low yields for appreciation potential and liquidity.
• Tier 2 markets (Austin, Nashville, Denver, Seattle): 4–6% cap rates. Balance of growth and income.
• Tier 3 markets (Cleveland, Memphis, Indianapolis, Kansas City): 6–10%+ cap rates. Higher cash returns, lower appreciation expectations, higher management intensity.

By property type:

• Class A multifamily (new, amenitized): 4–5%
• Class B multifamily (value-add opportunity): 5–7%
• Class C multifamily (older, lower-income): 7–10%
• Single-family rentals: 4–7% depending on market
• Commercial (NNN leases): 4–7%
• Self-storage: 5–7%

For individual investors, a common rule of thumb: if the cap rate is below the 10-year Treasury yield plus 2–3%, the risk premium may not justify the hassle of active management. In high-rate environments, this benchmark rises.

Cap Rate vs. Cash-on-Cash Return: What's the Difference?

This distinction confuses many new investors. Both measure investment return, but they answer different questions:

Cap Rate is a property metric, not an investor metric. It measures the return relative to total property value, ignoring financing. Two investors buying the same property with different mortgages have the same cap rate.

Cash-on-Cash Return is an investor metric. It measures the annual cash income relative to the cash you actually deployed (down payment + closing costs + renovations). Investors with different leverage get different CoC returns on the same property.

Example: You buy a $300,000 property at a 6% cap rate ($18,000 NOI) with $70,000 down. Your mortgage costs $16,200/year ($1,350/month). Cash flow = $18,000 − $16,200 = $1,800/year. CoC return = $1,800 ÷ $70,000 = 2.6%.

Same property, different scenario: 30% down ($90,000), lower mortgage of $13,800/year. Cash flow = $4,200. CoC = 4.7%.

The cap rate (6%) stayed constant; the CoC varied dramatically based on financing. Use cap rate to compare properties; use cash-on-cash to evaluate your specific investment given your financing terms.

Using Cap Rate to Value Properties

Cap rate works in reverse too: if you know the market cap rate and a property's NOI, you can calculate what the property should be worth. This is the foundation of commercial real estate valuation.

Property Value = NOI ÷ Cap Rate

If a commercial property generates $50,000 NOI and comparable properties in the area sell at a 6% cap rate: $50,000 ÷ 0.06 = $833,333 implied value.

This has practical implications for negotiations: if you can increase a property's NOI by $5,000/year (through higher rents, lower vacancy, or expense reduction) in a 6% cap rate market, you've added $83,333 in property value. This is the math behind value-add investing.

Practical example: You buy a small apartment building for $500,000 at a 6% cap rate ($30,000 NOI). Through renovations and improved management, you raise NOI to $38,000. At the same 6% market cap rate, the property is now worth $633,000 — a $133,000 gain on your value-add work.

Cap Rate and Interest Rates: Why They're Connected

Cap rates don't exist in a vacuum — they move in relation to interest rates. When financing costs rise, investors require higher returns from properties, which pushes cap rates up and prices down. This is why real estate values fell when rates jumped from 3% to 7% in 2022–2023: the cap rate on properties needed to increase to justify ownership, which meant prices had to decline.

The "spread" between cap rates and 10-year Treasury yields is a key metric institutional investors monitor. Historically, real estate cap rates run 150–250 basis points (1.5–2.5%) above the 10-year Treasury. When that spread compresses (cap rates approach or fall below Treasury yields), real estate looks overvalued relative to risk-free income. When the spread widens, real estate looks attractive.

For individual investors: in a high-interest-rate environment, require higher cap rates before purchasing. The opportunity cost of capital is real — if you can earn 5% risk-free on Treasuries, a 5% cap rate on a management-intensive rental property is not an adequate premium for the work and risk involved.

Common Cap Rate Calculation Mistakes

Even experienced investors make these errors:

1. Including mortgage payments in the expense calculation: NOI explicitly excludes debt service. Mortgage payments reflect your financing choice, not the property's income generation. Including them gives you cash flow, not NOI — a different metric.

2. Using gross rent instead of effective gross income: Always subtract vacancy from gross rent before calculating NOI. Assuming 100% occupancy produces an inflated cap rate.

3. Forgetting CapEx reserves: Operating expenses should include a reserve for capital expenditures (major repairs/replacements). Excluding CapEx makes cap rates look artificially high.

4. Using asking price instead of market value: For acquisition analysis, use the asking price. For portfolio analysis, use current market value. The cap rate changes as property values change — a property you bought for $200,000 that's now worth $350,000 has a much lower cap rate today than when you bought it.

5. Not including property management: If you self-manage now but might not in the future, include a management fee (8–12% of rent) to see the property's true cap rate. Self-management is a job — the cap rate should account for the cost of replacing that work.

Frequently Asked Questions

Is a higher or lower cap rate better?

It depends on your goals. A higher cap rate means more current income relative to price — better for cash flow investors. A lower cap rate typically reflects a more desirable property in a stronger market — better for appreciation-focused investors. Neither is objectively superior; the right cap rate depends on your investment strategy, risk tolerance, and the role the property plays in your portfolio.

Does cap rate include property taxes?

Yes. Property taxes are an operating expense and should be included when calculating NOI. Omitting property taxes overstates NOI and produces an inflated cap rate. Taxes, insurance, maintenance, property management fees, and utilities (where applicable) all belong in the operating expense calculation.

What's the difference between cap rate and ROI?

Cap rate is a narrow income-to-value metric that ignores financing and focuses on the property's operating performance. ROI (return on investment) is broader and can include appreciation, principal paydown, tax benefits, and cash flow. Cap rate is useful for property comparison; total ROI is useful for evaluating your personal investment performance.

Can cap rate be used for single-family rentals?

Yes, though it's more commonly used for commercial and multi-family properties. For single-family rentals, cash-on-cash return is often more practically useful because single-family buyers use more leverage and the financing terms significantly affect actual returns. That said, using cap rate to compare multiple SFR opportunities is still valid — it normalizes for different financing strategies.