The cap rate formula
Cap rate = NOI ÷ property price, expressed as a percentage. NOI is annual gross rent minus operating expenses, taxes, insurance, maintenance, management, and vacancy, excluding mortgage payments and income taxes, which makes cap rate a leverage-free yield. Ignoring financing lets one axis compare a Miami condo against a Cleveland fourplex.
Put plainly: cap rate tells you what the real estate itself earns per dollar of price, the bond-yield view of a building, before any loan or tax return enters the picture.
Because financing is ignored, cap rate lets you compare an all-cash condo in Miami against a fourplex in Cleveland on a single axis. It is the closest thing real estate has to a bond yield.
Worked example
A $300,000 duplex collecting $3,000 a month grosses $36,000 a year. After $9,000 in taxes, insurance, upkeep, and vacancy, NOI is $27,000. Divide: $27,000 ÷ $300,000 = 9.0% cap rate. The same $27,000 NOI on a $450,000 price is a 6.0% cap. Financing changes cash-on-cash, never the cap rate.
The lesson in that second number: the same income for a higher price means you are paying more per dollar of rent.
Worked example 2: when a high cap rate is a trap
A high cap rate is not automatically a good deal. It is often the price of risk, quoted as a yield. A $120,000 duplex collecting $1,600 a month grosses $19,200 a year. After $3,600 in taxes, insurance, upkeep, and vacancy, NOI is $15,600. Divide: $15,600 ÷ $120,000 = 13.0% cap rate. On paper that beats the 9% duplex from the first example by four full points.
Now the part the 13% hides. That $3,600 expense line is the seller's number, and it assumes no deferred roof, no furnace on its last season, no turnover. Add a $6,000 roof and one vacant month and NOI falls to $8,000, a real cap of 6.7%. The 13% was never the building's yield. It was the listing's optimism.
High caps cluster where buyers are scarce: a declining street, a building with repairs queued up, tenants on month-to-month who can leave with the rent. The market is not handing you extra return for free. It is charging you less because it expects the income to shrink.
The lesson mirrors the first example in reverse. There, a higher price for the same income meant paying more per dollar of rent. Here, a lower price for the same stated income means you are being paid to carry risk someone else priced in. Read a high cap rate as a question, not an answer.
Reverse: what's my property worth at a target cap rate?
Value = NOI ÷ target cap rate. Enter a target cap rate and the formula tells you the maximum price to pay for a given NOI. Instead of evaluating a listed price, you set your required return and back into your maximum offer.
Walk it with a real number. A property produces $23,200 of NOI. At a 6% target cap rate the maximum price is $23,200 ÷ 0.06, so $386,667. At an 8% target the same income supports only $23,200 ÷ 0.08, so $290,000. The building did not change. Your required return did, and it moved the ceiling on what you can pay by nearly $97,000.
This is the working investor's version of the formula. The seller quotes a price and hopes you will accept the cap rate it implies. You do the reverse: you decide the return you need first, then let the NOI and that target set the most you will offer. If the asking price sits above your number, the deal fails your test no matter how the listing reads.
It also tells you where to negotiate. If a property is listed at $360,000 and you need a 7% return, your maximum offer is $23,200 ÷ 0.07, so about $331,000. You now know the gap between ask and your ceiling, and can negotiate toward it or walk. Set your target, run the income, and the price you should pay stops being a guess.
Case study: the Cleveland fourplex
A cap rate can clear the bar while the deal still fails the bank. This fourplex showed a healthy 6.9% cap, and no lender would touch it. The number that killed the deal was not the cap rate but the coverage. The inputs: $280,000 purchase, $2,400 a month in rent, $9,600 a year in expenses. That grosses $28,800, leaves NOI of $19,200, and divides to a 6.9% cap rate, right in the healthy band for the market.
The $2,400 was not the seller's figure. The buyer pulled listings for similar four-unit buildings in the same submarket, matched on condition class, and found $575 to $625 a unit. At $600 a door the $2,400 total was market rent, not wishful thinking, so the NOI survived contact with reality.
With 20% down at 6.4% on 30 years, the calculator shows annual debt near $16,800, cash flow around $2,400 a year, cash-on-cash of 4.3%, and a DSCR of 1.14×. Read those together: the cap rate said the building was fairly priced for its income, the 4.3% cash-on-cash said the buyer's money barely beat a savings account, and the 1.14× DSCR said the property covered its own loan only 1.14 times over. Most lenders want 1.25×. The deal was fine as a building and unfundable as a loan.
The fix lives on the financing side, not the building. Raise the down payment to 30% and the loan drops to $196,000, annual debt falls to about $14,700, and DSCR climbs to 1.31×, past the 1.25× line. Or keep 20% down and find a lender near 5.5%, and coverage lands at 1.26×. Either move leaves the cap rate untouched, because cap rate never sees the loan.
The lesson: a good cap rate does not guarantee a fundable deal. Cap rate judges the building; DSCR judges whether a bank will lend on it. Underwrite both before you book the inspection.
What is a good cap rate?
For residential rentals, 6–10% is the typical band. Under 4% usually means a prime market pricing in appreciation; above 10% usually prices in risk, weak tenants, deferred repairs, or optimistic expenses. A cap rate is only as honest as the NOI behind it. Check yours against local comps, not national headlines.
The classic shapes: under-4% caps in gateways like Los Angeles or Manhattan, where appreciation does half the work; double-digit caps in declining neighborhoods or buildings with big-ticket repairs queued up.
What moves cap rate
Three levers move cap rate: price, expenses, rent reality. A 5% cheaper price lifts the cap 5% at the same NOI; lower costs lift the income the cap rate divides; honest vacancy and maintenance keep earned cap equal to calculated cap. On price and rent alone, a one-look rent-to-price test shows how far off the deal is.
On expenses, the usual wins are concrete: self-managing, re-shingeling before tenants leave, and shopping insurance, each lifts the income directly. And model honestly, or your cap will match the listing agent's advertisement instead of the return you actually earn.
Cap rate vs. cash-on-cash, GRM, and DSCR
Cap rate and GRM ignore financing and judge the building, cheap income or fast screen. Cash-on-cash and DSCR include your loan and judge your money, leveraged return and lender coverage. Use cap rate to decide what to pay, then cash-on-cash and DSCR to decide how to finance. Confusing them is how investors overpay with cheap debt.
Investors argue most when they mix these up. Keep the building questions (cap, GRM) separate from the money questions (cash-on-cash, DSCR) and each answer stays clean.
A 5% cap property bought with 25% down at 7% interest can show negative cash-on-cash, not because the building is mispriced but because the debt costs more than the yield. The same building at a 9% cap with 50% down cash-flows at identical rates. Use cap rate to decide what to pay and GRM to screen fast, then let cash-on-cash and DSCR decide how to finance. Check only one and you are underwriting with half the picture.
These six metrics judge the same deal from different angles. Some ignore your loan and price the building; others include it and price your money. Here is what each one counts, and when to reach for it.
| Metric | Formula | Counts expenses? | Counts your loan? | Best for |
|---|---|---|---|---|
| Cap Rate | NOI ÷ price | Yes | No | Judging the building |
| Net Operating Income | rent − operating expenses | Yes | No | The income before debt |
| Cash-on-Cash Return | cash flow ÷ cash invested | Yes | Yes | Your leveraged return |
| Gross Rent Multiplier | price ÷ annual rent | No | No | A fast two-number screen |
| DSCR | NOI ÷ annual debt | Yes | Yes | Whether a lender passes it |
| 1% Rule | monthly rent ÷ price ≥ 1% | No | No | An instant pass/fail |
Every metric links to its own free calculator above.
Cap rate vs the other metrics
Cap rate prices the building; the rest price your money or your financing, so no single metric can carry a decision alone. The failure modes matter as much as the formulas. Each ratio misleads in a predictable direction, and knowing which way it leans tells you when to distrust it. The table above shows what each metric counts; this one shows when each earns its place and when it quietly lies.
The same building with a renovation and sale exit is priced differently: when the exit is a sale rather than a hold shows the full flip math.
Each metric answers a different question, and each one fails in its own way. Use cap rate to price the building, cash-on-cash to price your money, DSCR to price the loan, and GRM to screen. Then check the right-hand column before trusting any of them.
| Metric | What it measures | Formula | When to use | When it lies |
|---|---|---|---|---|
| Cap Rate | The building's unleveraged yield | NOI ÷ price | Deciding what to pay for the income | When the seller's NOI is optimistic |
| Cash-on-Cash Return | Your leveraged cash return | cash flow ÷ cash invested | Judging what your money actually earns | When a cheap loan disguises a thin deal |
| DSCR | How many times NOI covers the loan | NOI ÷ annual debt | Whether a lender will fund it | When a long term flatters weak coverage |
| Gross Rent Multiplier | Years of rent to repay the price | price ÷ annual rent | Screening many deals fast | When expense loads differ across buildings |
Run cap rate first to price the building, then the others to price your money and your financing.
How these numbers are calculated
NOI is annual gross rent minus operating expenses, before mortgage and income tax. Cap rate is NOI ÷ price; cash-on-cash is (NOI − mortgage) ÷ cash invested; DSCR is NOI ÷ annual debt; GRM is price ÷ annual rent. Percentages round to one decimal, dollars to whole dollars. An all-cash deal shows no debt line, and cap rate equals cash-on-cash only when no closing costs sit in the basis; add them and cash-on-cash runs slightly lower.
Two conventions sit behind those one-liners: mortgage payments use the standard 30-year fixed amortization formula on your interest rate and down payment, so a deal left on all-cash shows no debt line and, absent closing costs in the basis, cap rate equals cash-on-cash, percentages round to one decimal and dollars to the nearest dollar, and the 1% rule is a pure screen that passes when monthly rent is at least 1% of the price.
Cap rate myths worth skipping
A higher cap rate is always better. Not true: a 12% cap is usually the market charging you for vacancy, deferred repairs, or a weak neighborhood. The number is high because the risk is.
Cap rate tells you if the deal is good. It tells you if the building is cheap for its income. Whether the deal is good for you depends on your financing, your taxes, and your hold, which is exactly what cash-on-cash and DSCR measure.
The listing cap rate is real. It is the seller's best guess at NOI. Rebuild it from your own rent comps and a full expense sheet, and it will usually land a point or two lower.
Match the cap rate and you can compare cities. A 6% cap in a growing market and a 6% cap in a shrinking one are different investments; the ratio matches, the future does not.
Three cap-rate mistakes that burn buyers
The three deal-killers: trusting the seller's NOI, dividing by price alone instead of price plus repairs, and comparing cap rates across different risk classes. Fix all three by rebuilding NOI from your own comps, using all-in basis, and comparing only similar buildings. Price plus repairs is the only honest denominator.
The details that sting: list sheets that count parking from units that don't exist; a $40,000 rehab turning a 7.0% paper cap into a 6.2% all-in cap on price plus closing plus rehab; a Class-A fourplex with five-year leases versus three scattered SFRs with turnover risk, same numerator math, different denominator of headaches.
Trusting the seller's NOI, in real numbers: a listing claims $24,000 of net income on a $320,000 fourplex, a 7.5% cap. Rebuild it with actual taxes, a realistic vacancy allowance, and a management line, and NOI drops to $19,200, a real 6.0% cap. At that same 7.5% yield, the honest income supports a $256,000 price, so the cost is the $64,000 of value you paid for income that never existed. The fix: source every expense yourself and treat the listing sheet as a lead, not a number.
Dividing by price alone: a $200,000 duplex at a $14,000 NOI shows a clean 7.0% cap. Add $12,000 in closing costs and immediate repairs and the all-in basis is $212,000, a real 6.6% cap. That costs you the half-point of yield you thought you bought, every year you hold. The fix: always divide by price plus closing plus repairs, never the sticker.
Comparing across risk classes: an 8% cap on a Class-C walk-up and an 8% cap on a Class-A garden complex read as equals and are not. The first carries turnover, credit risk, and deferred repairs the second does not, so matching numbers hide the worse deal. The fix: compare a cap rate only against buildings of the same class, age, and tenant base.
How cap rates differ by market type
Cap rates are relative to their market, not absolute. The same 6% is a strong yield in one city and a red flag in another. Four broad market types price risk differently, and comparing across them on the number alone is how buyers talk themselves into bad deals.
Coastal metros carry the lowest cap rates. Prices there are bid up by buyers paying for appreciation as much as income, so a 4% cap can clear because the real return is the rising value of the land. Cash flow is thin by design.
Midwest cash-flow markets run higher cap rates. The income, not the appreciation, does the work, so the building has to pay you from rent alone. The trade is a heavier management burden: older housing stock, more turnover, more hands-on upkeep for every point of yield.
Sunbelt growth markets sit between the two. Rents and prices both move with in-migration, so cap rates land in the middle and the bet is split between income now and growth later.
Rural markets show the highest cap rates of all, and the thinnest buyer pools. The number is high because demand is low and resale is slow. You are paid a premium to hold an asset that is hard to sell.
The practical rule: calibrate a deal against its own market's median cap rate, not a national figure. A below-market cap in a coastal metro can still be fair; an above-market cap in a rural county can still be a trap.
How to find your market's cap rate
Pull 10–15 recent listings for your property type, estimate market rent, subtract taxes and a 35–45% expense load, then take the median rent ÷ price. That median is your market's cap rate. Calibrate every deal against it. Below-median deals mean underestimated expenses; above-median with no purchase means excess caution.
Build it from public records: market rent from vacancy ads, taxes from the assessor's rolls, and sales instead of listings wherever records show the rent.
Which calculator to use next
Rebuild income with the NOI calculator, clear the lender's 1.25× test with the DSCR calculator, screen on price and rent with GRM or the 1% rule, and compare quoted yields with gross and net yield side by side. Start with income, end with yield.
Cap rate answers one question, and most deals need a couple more before you can act. Run them in this order and each number sets up the next. If the plan is recycling one down payment across several doors, run the same numbers through the BRRRR calculator to see how much capital each refinance hands back.
Cap rate is also a single-year number, so it cannot say what the property pays over ten of them. The way to carry the same yield through every year of rent, the mortgage, and the sale is to run the full cash flow projection.
Every metric above divides a monthly rent, and a tenancy rarely begins on the 1st. The gap between one tenant leaving and the next arriving is real vacancy, and the prorated rent calculator prices the partial month at each end of it, so the rent line inside your NOI counts the days that were actually paid for rather than a rounded full month.
Frequently asked questions
20 answers, no funnel.
How to use a cap rate calculator?
Enter the price, monthly rent, and annual expenses; the calculator divides NOI by price instantly. Then stress-test it, raise vacancy, add a repair, change the price, and watch which metric breaks first.
What is a good cap rate for a rental property?
Most buy-and-hold investors target 6–8% in stable markets and accept 4–5% only where appreciation is strong. Above 10% usually signals risk the seller has priced in.
Does cap rate include the mortgage?
No. Cap rate is unleveraged, it uses NOI before any debt service. Use cash-on-cash return to see what financing does to your actual return.
Why do cap rates differ by city?
They track perceived risk and growth. Low-cap cities (4–5%) are expensive, liquid, appreciating markets; high-cap cities (8–12%) offer cash flow in exchange for weaker growth and higher vacancy risk.
Is a 7% cap rate good?
For residential it is a solid middle-of-the-road return. Whether 7% is "good" depends on your market, how conservative your expense assumptions are, and your goal, appreciation versus cash flow.
Should cap rate be calculated on price or total investment?
Conservative buyers use an all-in cap: NOI ÷ (price + closing costs + immediate repairs). It is always lower than the listing cap and closer to what your money actually earns.
Can two identical cap rates be different deals?
Yes. Cap rate ignores expense quality, tenant mix, lease length, and building age. A 7% cap with 90%-occupied three-year leases beats a 7% cap with month-to-month students, even though the numbers match.
What does a 7.5% cap rate mean?
A 7.5% cap rate means $7.50 a year per $100 of price, before financing, inside the healthy 6–10% band. Unlike a 4% cap, it pays you from the building itself instead of betting on appreciation.
Is a 5% cap rate good?
A 5% cap rate is acceptable only where appreciation does real work, prime, growing markets with strong demand. Anywhere else, 5% means you overpaid or underestimated expenses: the band for cash flow starts at 6%.
What does a 6% cap rate mean?
A 6% cap rate means $6 a year per $100 of price, the floor of the healthy band. It works with honest expenses in a stable market; with optimistic inputs, a quoted 6% is often a real 5%.
What is the difference between cap rate and ROI?
Cap rate is the building's unleveraged yield, NOI ÷ price, before any loan. ROI is your total return after financing, costs, and appreciation. Cap rate prices the property; ROI prices your money in the whole deal.
Do I use gross rent or net rent for cap rate?
Neither directly. Start with gross scheduled rent, subtract vacancy and operating expenses to get NOI, then divide by price. Using gross rent alone overstates the yield and inflates the cap rate.
How do I calculate cap rate on a property I already own?
Use current market value, not what you paid. Estimate today's NOI from actual rent and expenses, then divide by the property's present value. That tells you whether holding still beats selling.
What is a safe cap rate?
A safe cap rate sits in the 5 to 8% band in a stable market with honest expenses. Safety comes from conservative vacancy and repair assumptions, not the number itself. A 6% cap on verified income beats a 9% cap on optimistic figures.
Why is a high cap rate bad?
A high cap rate is not always bad, but it usually prices in risk: weak tenants, deferred repairs, or a declining area. The market pays you more because it expects the income to shrink. Investigate the reason before trusting the yield.
What cap rate is too high?
Above about 10 to 12% the yield usually signals serious risk, not a bargain. At that level the price reflects expected vacancy, credit loss, or major repairs. Treat any double-digit cap as a prompt to find the hidden problem, not a reason to buy.
Is 8% a good cap rate?
Yes, for most buy-and-hold investors 8% is a strong return that beats typical index funds with real cash flow. It clears the healthy band comfortably, provided the NOI behind it is rebuilt from your own expense figures rather than the seller's.
Is 12% a good cap rate?
Rarely as advertised. A true 12% cap exists in high-risk markets or distressed buildings, where it compensates for vacancy and repair exposure. If a deal shows 12% on paper, the honest rebuilt figure usually lands several points lower.
Should cap rate be higher than the interest rate?
Ideally yes. When the cap rate exceeds your mortgage rate, leverage works for you and cash-on-cash rises above the cap. When the rate is higher, each borrowed dollar drags your return down. Most deals sit near that crossover at today's rates.
What is the rule of thumb for cap rate?
The common rule: 6 to 10% is the healthy band for residential rentals. Below 4% prices in appreciation, above 10% prices in risk. Use it as a screen, then verify against your market's median and your own rebuilt NOI.