Cap Rate: How to Calculate It and What’s a Good One
Last updated 06/08/2026 by
Andrew Latham
Edited by
Andrew Latham
Summary:
A capitalization rate, or cap rate, is the ratio of a property’s annual net operating income to its market value, expressed as a percentage.
It estimates the unleveraged return an investor could expect from a rental property in a single year.
- The formula: Net operating income divided by property value.
- What it measures: Annual return relative to price, ignoring financing.
- Higher cap rate: More income per dollar of price, but usually more risk.
- Lower cap rate: Less income per dollar, often a stable, in-demand market.
Comparing two rental properties by price alone tells you almost nothing. The cap rate puts them on the same footing, so a $400,000 duplex and a $1.2 million fourplex can be measured side by side.
How to calculate the cap rate
Cap rate is calculated by dividing a property’s net operating income by its current market value or purchase price. The result is a percentage that represents the annual return if you bought the property in cash.
The formula is: Cap rate = Net operating income / Property value.
Net operating income (NOI) is the annual rental income minus operating expenses like taxes, insurance, maintenance, and management, but not mortgage payments. A property with $60,000 in NOI and a $1 million value has a 6% cap rate.
Good to know: Cap rate deliberately excludes mortgage costs. That’s what makes it useful for comparing properties, since two investors with different loans can still evaluate the same building on equal terms.
What a good cap rate looks like
There is no universal “good” cap rate, because the right number depends on the market, property type, and your risk tolerance. Most residential rentals fall somewhere between 4% and 10%.
The trade-off built into the number is the key to reading it:
- Higher cap rates (8% and up): More income relative to price, often found in secondary markets or properties with more risk or management demands.
- Lower cap rates (4% to 5%): Less income per dollar, typical of high-demand cities where investors accept lower returns for stability and appreciation.
A high cap rate is not automatically better. It can signal a declining area, a difficult tenant base, or deferred maintenance that will eat into returns.
Pro Tip
Always calculate NOI yourself rather than trusting a seller’s number. Listings often understate expenses or use optimistic rent, which inflates the cap rate. Pull actual tax bills, insurance quotes, and a realistic vacancy allowance before you trust the figure.
What cap rate doesn’t tell you
Cap rate is a snapshot of one year’s return at one moment, so it leaves out several things that matter to an investment.
- Financing: It ignores your mortgage, so it doesn’t reflect your actual cash return after loan payments.
- Appreciation: It measures income, not the property’s potential rise in value.
- Future changes: It assumes current rent and expenses hold steady.
- Major repairs: A new roof or HVAC system isn’t an operating expense but still affects returns.
For the return after financing, investors turn to cash-on-cash return, which factors in the mortgage. Cap rate and cash-on-cash answer different questions, and serious buyers use both.
How to use cap rate to compare properties
- Gather the income: Total the annual rent and any other income each property generates.
- Subtract real expenses: Deduct taxes, insurance, maintenance, management, and vacancy to find NOI.
- Divide by price: Divide each property’s NOI by its asking price to get the cap rate.
- Compare within the market: Measure properties against others in the same area and class, not across different markets.
- Investigate outliers: If one cap rate looks unusually high, find out why before assuming it’s the better deal.
Because the cap rate sets price against income, it also works in reverse: dividing a property’s NOI by a target cap rate gives an estimated value, a method appraisers use for income properties.
Related reading on real estate investing
- Net income: the broader profit concept that net operating income builds on.
- Loan-to-value: how lenders size financing against a property’s worth.
- Appraisal: how professionals value income properties, often using cap rates.
- Home equity: the ownership stake that grows as a property’s value rises.
Frequently asked questions
What is a good cap rate for rental property?
Most residential rentals fall between 4% and 10%, but the right number depends on the market and risk. Higher cap rates mean more income per dollar but often more risk, while lower cap rates are common in stable, high-demand areas.
How do you calculate cap rate?
Divide a property’s annual net operating income by its market value or purchase price. For example, $50,000 of NOI on a $1 million property is a 5% cap rate.
Does cap rate include the mortgage?
No. Cap rate excludes financing on purpose, so it measures the property’s return independent of how it’s paid for. For the return after loan payments, use cash-on-cash return instead.
Is a higher or lower cap rate better?
It depends on your goals. A higher cap rate delivers more income relative to price but often comes with more risk, while a lower cap rate signals a stable market with appreciation potential.
What is net operating income?
Net operating income is annual rental income minus operating expenses such as taxes, insurance, maintenance, and management. It excludes mortgage payments and one-time capital costs.
Key takeaways
- Cap rate is net operating income divided by property value, expressed as a percentage.
- It estimates a property’s annual unleveraged return and lets you compare properties on equal terms.
- Higher cap rates mean more income per dollar but usually more risk; lower cap rates suit stable markets.
- It excludes financing, appreciation, and major repairs, so pair it with cash-on-cash return.
- Always calculate NOI from real numbers rather than a seller’s estimate.
When a rental property’s cap rate pencils out, financing terms decide whether the deal actually works. You can compare mortgage lenders to find investment property rates, which vary widely as SuperMoney’s mortgage industry study shows across the lender landscape.
Andrew is the Content Director for SuperMoney, a Certified Financial Planner®, and a Certified Personal Finance Counselor. He loves to geek out on financial data and translate it into actionable insights everyone can understand. His work is often cited by major publications and institutions, such as Forbes, U.S. News, Fox Business, SFGate, Realtor, Deloitte, and Business Insider.
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