What is the cap rate of this property?
Calculate capitalization rate (cap rate) for real estate investments. Determine property value, net operating income, and investment returns.
- Cap rate
- 6.63%
A property worth $350,000.00 with $10,980.00 a year of operating expenses and $23,220.00 a year of net operating income has a cap rate of 6.63%.
- Net operating income (NOI)
- $23,220.00
- Gross income per year
- $36,000.00
- Vacancy loss per year
- $1,800.00
- Effective gross income
- $34,200.00
- Operating expenses as entered
- $10,980.00 a year
- Operating expenses per year
- $10,980.00
Cap rate: 6.63%. A property worth $350,000.00 with $10,980.00 a year of operating expenses and $23,220.00 a year of net operating income has a cap rate of 6.63%.
The results are estimates for information only. They are not financial, tax, or legal advice. Check the numbers with your lender or a qualified professional before you decide. Terms of use
How to calculate
Computes a rental property’s net operating income and capitalization rate (NOI ÷ value), or the value that gives a target cap rate.
Example with the default inputs (What do you want to find? Cap rate, Property value $350,000.00, Rent per month $2,800.00, Other income per month $200.00, Vacancy rate 5%, Enter the expenses below Per year, Property taxes $4,200.00, Insurance $1,800.00, Maintenance and repairs $2,100.00, Property management $1,680.00, Other expenses $1,200.00): A property worth $350,000.00 with $10,980.00 a year of operating expenses and $23,220.00 a year of net operating income has a cap rate of 6.63%.
Method: Cap rate = NOI ÷ property value, where NOI = (rent + other income) × 12 × (1 − vacancy) − operating expenses.
- Rent and other income are per month; the vacancy rate applies to both.
- Operating expenses are per year, or per month times 12 when the expense period is monthly.
- Mortgage payments, income tax, depreciation, and capital improvements are not operating expenses.
Worked examples
Each example is checked against the calculator on every build.
- What do you want to find? Cap rate, Property value $350,000.00, Rent per month $2,800.00, Other income per month $200.00, Vacancy rate 5%, Enter the expenses below Per year, Property taxes $4,200.00, Insurance $1,800.00, Maintenance and repairs $2,100.00, Property management $1,680.00, Other expenses $1,200.00 gives Net operating income (NOI) $23,220.00, Target cap rate 6.634286%, Gross income per year $36,000.00, Vacancy loss per year $1,800.00, Operating expenses per year $10,980.00.Source: Net operating income and operating expenses: Internal Revenue Service, Publication 527, Residential Rental Property (what counts as a rental expense). https://www.irs.gov/publications/p527
- What do you want to find? Cap rate, Property value $1,000,000.00, Rent per month $10,000.00, Other income per month $200.00, Vacancy rate 10%, Enter the expenses below Per year, Property taxes $12,000.00, Insurance $4,000.00, Maintenance and repairs $6,000.00, Property management $12,000.00, Other expenses $3,000.00 gives Net operating income (NOI) $73,160.00, Target cap rate 7.316%.Source: Net operating income and operating expenses: Internal Revenue Service, Publication 527, Residential Rental Property (what counts as a rental expense). https://www.irs.gov/publications/p527
- What do you want to find? Property value, Target cap rate 6.5%, Rent per month $2,800.00, Other income per month $200.00, Vacancy rate 5%, Enter the expenses below Per month, Property taxes $350.00, Insurance $150.00, Maintenance and repairs $175.00, Property management $140.00, Other expenses $100.00 gives Net operating income (NOI) $23,220.00, Property value $357,230.77.Source: Net operating income and operating expenses: Internal Revenue Service, Publication 527, Residential Rental Property (what counts as a rental expense). https://www.irs.gov/publications/p527
How the cap rate is worked out
- Gross income per year = (rent per month + other income per month) × 12.
- Vacancy loss = gross income × vacancy rate.
- Effective gross income = gross income − vacancy loss.
- Operating expenses per year = property taxes + insurance + maintenance + management + other expenses. When the expenses are entered "Per month", the sum is multiplied by 12. The switch says how the typed numbers are meant: switching it keeps the typed numbers and reads them in the new period (it does not convert them). The answer names the typed sum with its period, for example "$10,980.00 a month of operating expenses".
- Net operating income (NOI) = effective gross income − operating expenses.
- Cap rate = NOI ÷ property value × 100.
To value a property instead, choose "Property value": value = NOI ÷ (target cap rate ÷ 100).
Assumptions
- The vacancy rate applies to rent and other income alike.
- Mortgage payments, income tax, depreciation, and capital improvements are left out, because they are not operating expenses.
- A negative NOI gives a negative cap rate: the property costs more to run than it earns.
- With a negative or zero NOI there is no value from a cap rate, and the calculator says so.
Worked examples by hand
The default property. Gross income = (2,800 + 200) × 12 = $36,000. Vacancy loss = 5% × 36,000 = $1,800, so effective gross income = $34,200. Expenses = 4,200 + 1,800 + 2,100 + 1,680 + 1,200 = $10,980. NOI = 34,200 − 10,980 = $23,220. Cap rate = 23,220 ÷ 350,000 = 6.63%.
Value at a 6.5% cap rate, expenses per month. Monthly expenses 350 + 150 + 175 + 140 + 100 = $915, or $10,980 a year, so NOI is again $23,220. Value = 23,220 ÷ 0.065 = $357,231.
A $1,000,000 building. Gross income = (10,000 + 200) × 12 = $122,400. Vacancy loss (10%) = $12,240, so effective gross income = $110,160. Expenses = 12,000 + 4,000 + 6,000 + 12,000 + 3,000 = $37,000. NOI = $73,160, and the cap rate is 73,160 ÷ 1,000,000 = 7.32%.
What is a Cap Rate? Understanding Capitalization Rate in Real Estate
The capitalization rate, commonly known as the "cap rate," is the most fundamental metric in commercial real estate investment. It represents the annual return on investment (ROI) for a property, expressed as a percentage, based on its current market value and net operating income (NOI).
Cap rates serve as a universal language among real estate investors, brokers, and appraisers, providing a standardized method for comparing the relative value and profitability of different income-producing properties.
Cap Rate Formula and Calculation
Cap Rate = (Net Operating Income ÷ Property Value) × 100
or simply: Cap Rate = NOI ÷ Property Value
This simple formula provides an unlevered rate of return, meaning it ignores financing costs and focuses purely on the property's operational performance relative to its market value.
Net Operating Income (NOI): The Foundation of Cap Rate Analysis
Net Operating Income is the total income a property generates minus all operating expenses, excluding financing costs and capital expenditures. It represents the property's true earning potential.
Income Sources
- Gross rental income
- Parking fees
- Laundry income
- Storage fees
- Other ancillary income
Operating Expenses
- Property taxes
- Insurance premiums
- Maintenance & repairs
- Property management fees
- Utilities (if paid by landlord)
- Vacancy allowance
How to Interpret Cap Rates: What Different Ranges Mean
Low Cap Rates (3% - 5%)
Indicate high-quality, low-risk properties in prime locations. These are typically Class A properties with stable, creditworthy tenants. Investors accept lower immediate returns for perceived safety and long-term appreciation potential.
Medium Cap Rates (5% - 8%)
Represent a balance between risk and return. These are usually well-maintained Class B properties in stable markets, offering respectable income streams without excessive risk.
High Cap Rates (8%+)
Signal higher perceived risk. These properties may be in less desirable locations, need significant maintenance, or have tenant quality issues. The higher yield compensates for additional risk.
Cap Rate vs. Other Real Estate Metrics
| Metric | Formula | Purpose | Key Difference |
|---|---|---|---|
| Cap Rate | NOI ÷ Property Value | Compare property profitability | Unlevered, ignores financing |
| Cash-on-Cash | (NOI - Debt Service) ÷ Cash Invested | Evaluate specific deal structure | Levered, includes financing |
| ROI | Total Return ÷ Total Investment | Measure overall profitability | Can include appreciation |
| GRM | Property Value ÷ Gross Rent | Quick property screening | Uses gross income, not NOI |
Factors That Influence Cap Rates
Market Factors
- Interest rates and cost of capital
- Economic conditions and GDP growth
- Market supply and demand dynamics
- Investor sentiment and risk appetite
- Inflation expectations
Property-Specific Factors
- Location and market desirability
- Property class and condition
- Tenant quality and lease terms
- Property type (multifamily, office, retail, etc.)
- Age and maintenance requirements
Limitations of Cap Rate Analysis
Important Considerations
- Static Metric: Cap rates are based on current NOI and don't account for future growth or decline
- Ignores Financing: Doesn't consider the impact of debt service on actual cash flow
- Excludes CapEx: Major capital expenditures are not reflected in the calculation
- Market Dependent: "Good" cap rates vary significantly by market and property type
- Data Quality: Results depend entirely on the accuracy of NOI and property value inputs
Best Practices for Using Cap Rate Analysis
1. Verify the Data
Never take NOI figures at face value. Perform thorough due diligence to verify income and expense data.
2. Compare to Market
Benchmark the property's cap rate against recent sales of comparable properties in the same submarket.
3. Consider the Full Picture
Use cap rate as an initial screening tool, then perform comprehensive analysis including DCF modeling.
4. Account for Growth
Consider the property's potential for income growth and value appreciation, not just current yield.
Conclusion: Using Cap Rate as Part of Your Investment Strategy
The capitalization rate is an essential tool in real estate investment analysis, but it should not be used in isolation. Successful investors combine cap rate analysis with comprehensive due diligence, market research, and long-term strategic planning. Remember that the cap rate is a starting point for analysis, not the final answer to whether a property is a good investment.
Other questions people ask
What is a cap rate (capitalization rate) and why is it important?
A cap rate is the most fundamental metric in commercial real estate investment, representing the annual return on investment for a property. It's calculated by dividing the Net Operating Income (NOI) by the property's current market value, expressed as a percentage. Cap rates are crucial because they provide a standardized way to compare different properties and assess their relative value and risk. For example, a 6% cap rate means the property generates 6% of its value in annual income before financing costs and taxes.
What is considered a good cap rate?
There is no single good cap rate. It depends on the property type, the market, and the risk. Lower cap rates usually mean lower-risk properties in prime locations, and higher cap rates suggest higher risk or less desirable areas. Compare a property with recent sales of similar properties in the same area. The best cap rate aligns with your investment goals, risk tolerance, and market conditions.
What is Net Operating Income (NOI) and how do I calculate it?
Net Operating Income (NOI) is the annual income generated by a property after deducting all operating expenses but before accounting for financing costs, income taxes, and capital expenditures. To calculate NOI: Start with gross rental income plus other income, subtract vacancy allowance to get effective gross income, then subtract operating expenses (property taxes, insurance, maintenance, management fees, utilities if paid by landlord). NOI is the foundation of cap rate analysis.
What's the difference between cap rate and cash-on-cash return?
Cap rate is an unlevered metric that ignores financing costs, while cash-on-cash return is a levered metric that includes debt service. Cap rate = NOI ÷ Property Value, while Cash-on-Cash = (NOI - Debt Service) ÷ Cash Invested. Cap rates are used to compare properties, while cash-on-cash evaluates specific deal structures. For example, a property might have a 6% cap rate but a 12% cash-on-cash return with leverage.
How do interest rates affect cap rates?
Generally, as interest rates rise, cap rates tend to expand (increase) because investors require higher yields to compensate for higher borrowing costs. However, this relationship isn't always direct due to other factors like market fundamentals, property type, and location-specific dynamics. The spread between cap rates and interest rates (the risk premium) also fluctuates based on market conditions and investor sentiment.
Why do cap rates vary by property type?
Different property types have varying risk profiles and operational characteristics. Multifamily and industrial properties typically have lower cap rates due to stable demand and lower operational complexity. Office and retail properties often have higher cap rates due to greater market volatility and operational risks. Hotels typically have the highest cap rates due to their operational intensity and sensitivity to economic cycles.
What are the limitations of using cap rates?
Cap rates are static metrics that don't account for future growth, financing costs, or capital expenditures. They provide a snapshot of current performance but don't capture the full investment picture. Other limitations include: they ignore appreciation potential, don't consider tax implications, and can be manipulated through aggressive NOI assumptions. For comprehensive analysis, combine cap rate analysis with DCF modeling and other metrics.
How do I use cap rates to value a property?
To value a property using cap rates, divide the property's NOI by the market cap rate for similar properties. For example, if a property has an NOI of $100,000 and similar properties trade at a 6% cap rate, the estimated value would be $100,000 ÷ 0.06 = $1,666,667. Choose Property value in the calculator to do this. This method is particularly useful for income-producing properties and provides a quick way to assess whether a property is priced fairly relative to the market.
What factors cause cap rates to change over time?
Cap rates change due to macroeconomic factors (interest rates, economic growth, inflation), market-specific factors (supply and demand, local economic conditions), and property-specific factors (tenant quality, lease terms, property condition, location desirability). Market sentiment and investor appetite for risk also play significant roles in cap rate movements.
Should I buy a property with a high or low cap rate?
The choice depends on your investment strategy and risk tolerance. Low cap rate properties (3-5%) offer stability and potential appreciation but lower immediate returns. High cap rate properties (8%+) offer higher immediate returns but typically come with higher risk and may require more active management. Consider your goals: income generation vs. appreciation, active vs. passive management, and your timeline for holding the property.
How does location affect cap rates?
Location significantly impacts cap rates. Properties in prime, high-demand areas typically have lower cap rates (3-6%) because they're considered safer investments with better appreciation potential. Properties in secondary markets or less desirable areas usually have higher cap rates (7-12%) to compensate for increased risk and potentially lower appreciation. Even within the same city, cap rates can vary dramatically between neighborhoods.
What's the relationship between cap rate and property value?
Cap rate and property value have an inverse relationship. When cap rates increase, property values typically decrease (assuming NOI stays the same). When cap rates decrease, property values typically increase. This is because cap rate = NOI ÷ Property Value. For example, if NOI is $50,000: at 5% cap rate, value = $1,000,000; at 6% cap rate, value = $833,333. This relationship is fundamental to understanding market dynamics.
How do I compare cap rates across different properties?
When comparing cap rates, ensure you're using consistent assumptions: same vacancy rates, similar expense ratios, and comparable property types. Also consider factors beyond cap rate: property condition, location quality, tenant quality, lease terms, and growth potential. A property with a lower cap rate might be a better investment if it has stronger appreciation potential or better tenant stability. Always perform thorough due diligence.
What expenses are included in operating expenses for NOI calculation?
Operating expenses include all costs necessary to run the property day-to-day: property taxes, property insurance, maintenance and repairs, property management fees, utilities (if paid by owner), landscaping, HOA fees, pest control, marketing costs, and other routine expenses. They do NOT include mortgage payments, income taxes, capital improvements (like new roofs), or depreciation. Accurate expense estimation is crucial for reliable cap rate analysis.
How does vacancy rate affect cap rate calculations?
Vacancy rate directly impacts cap rate by reducing the effective gross income. A higher vacancy rate means less rental income, which lowers the NOI and consequently the cap rate. For example, if you expect 5% vacancy, you should reduce your gross rental income by 5% before calculating expenses. This provides a more realistic picture of actual returns and is essential for accurate property valuation.