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The Numbers, for Investors
The cap rate,
without the hype.
A cap rate is net operating income divided by property price: the annual return a property is expected to generate before debt service and before taxes. This page walks through the formula, a worked example, and an interactive calculator you can run on your own numbers in the browser.
The Definition
What a cap rate is
The cap rate, short for capitalization rate, is a single underwriting ratio: net operating income divided by the purchase price. Net operating income, or NOI, is the income the property produces after its operating expenses, before the mortgage payment and before income tax.
Expressed as a percentage, the cap rate approximates the annual return the property is expected to generate as if it were bought in cash. Because it ignores financing, it is the number investors use to compare buildings with different loans, or no loan at all, on their own merits.
The formula
Cap Rate = Net Operating Income ÷ Purchase Price
Net operating income: rent collected minus operating expenses, before debt service and before taxes.
Purchase price: the price of the property, or the value you are underwriting against.
The Worked Example
A $400,000 duplex, line by line
The same math a lender or an investor would run, kept simple on purpose.
- Purchase price
- $400,000
- Monthly gross income (rent)
- $3,200
- Annual gross income
- $38,400
- Vacancy allowance, 5%
- −$1,920
- Operating expenses, $800 per month
- −$9,600
- Net operating income (NOI)
- $26,880
The cap rate
$26,880 ÷ $400,000 = 6.72%
Same property, gross yield check: $38,400 ÷ $400,000 = 9.6%. The 9.6% counts rent before any expense is paid. The 6.72% counts what remains after operating costs. Both are real numbers. Only one is the cap rate.
Reading the Number
What higher and lower cap rates mean
Cap rates are read against their market, never in a vacuum.
Higher cap rate
A higher cap rate generally pairs with more perceived risk, or with stronger cash flow relative to price: an older building, a weaker tenant or market, heavier maintenance demands, or slower rent growth. The market prices that risk by demanding a larger income return. Higher is not automatically better.
Lower cap rate
A lower cap rate generally pairs with a more stable or premium market: strong demand, quality construction, creditworthy tenants, and a buyer pool willing to accept thinner income for more certainty. What looks low in one city can be entirely normal in another, so compare like for like.
The same building can trade at a different cap rate next year. Rates move with interest rates, vacancy and the market's appetite for risk, so compare properties in the same market, in the same time frame, with the same expense assumptions.
The Honest Read
Why the cap rate is only one number
The cap rate measures the asset, not your deal. Your return on the cash you actually invest, after the mortgage, is the cash-on-cash return, a different number that depends on your financing, your interest rate and your down payment.
The cap rate is also built from assumptions. It reflects the rents, vacancy and expenses you feed into it, and it says nothing about the roof, the HVAC, the lease expirations, the tenant's credit, the property tax reassessment after a sale, or what the market pays when you exit.
Use the cap rate to screen and to compare. Underwrite the deal line by line before you commit.
What NOI already includes
- Property taxes and insurance
- Property management and leasing costs
- Maintenance, repairs and utilities you pay
- Vacancy and collection loss
- Reserve for the normal, expected upkeep
Read This First
Gross yield is not a cap rate
A cap rate is only as good as the numbers that feed it. Three things trip up more buyers than anything else.
Advertised rates and gross yield are not cap rates
A listing, sign or pitch that quotes a ten percent return is usually computing rent before expenses. That is gross yield. Subtract every operating cost before the number can be called a cap rate.
Expenses must come out first
Net operating income subtracts property taxes, insurance, management, maintenance, utilities you pay, vacancy and every other operating cost. Skip them and you are not calculating a cap rate, you are calculating a hope.
Verify the broker's operating statement and rent roll
The seller's income figure is a starting point, not proof. Request the operating statement and the rent roll, confirm each unit's in-place rent and each expense line, and re-run the math with the confirmed numbers.
This page is educational and is not financial or investment advice. Nothing here is a recommendation to buy, sell or hold any property. Verify the numbers against the documents and review the deal with your own financial and tax advisors.
The Calculator
Run your own numbers
Enter the purchase price, monthly income, vacancy and operating expenses. The results update as you type, and the calculator shows gross yield and cap rate side by side so the difference is impossible to miss. All math runs in your browser; nothing is sent anywhere.
The results
- Annual gross income
- $38,400
- Vacancy deduction
- −$1,920
- Effective gross income
- $36,480
- Operating expenses, annual
- −$9,600
- Net operating income (NOI)
- $26,880
Gross yield
9.60%
Rent before expenses, divided by price
Cap rate
6.72%
NOI, divided by price, before debt
Gross yield counts rent before expenses. Cap rate counts net operating income after expenses. The gap between the two is the operating cost, and gross yield is not a cap rate.
Educational tool only, and not financial or investment advice. It assumes the figures you enter; it does not verify them.
Next Steps
Where the cap rate fits in your deal
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What Class A, B and C mean for age, condition, location, tenant profile, amenities and investment risk, with a quick comparison table.
Read the class guideBack to invest strategy
The full strategy: cash flow, appreciation, neighborhood thesis and the exit plan.
Visit the invest pageInvesting questions, answered
Rent rolls, cap rates, cash-on-cash, and the questions buyers actually ask before they commit.
Browse the investing Q and ABring the deal to Rob
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