Cap Rate Calculator
Cap Rate
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NOI
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GRM (Gross Rent Multiplier)
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Investment Rating
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How Cap Rate Works
The capitalization rate (cap rate) is the most widely used metric for evaluating the return potential of investment properties. It expresses the relationship between a property's net operating income and its purchase price as a percentage. According to the National Association of Realtors (NAR), cap rate is the primary screening metric used by commercial and residential investment property buyers to compare opportunities across different markets and property types.
Cap rate is financing-neutral, meaning it evaluates the property's return potential independent of how the purchase is funded. This makes it ideal for comparing properties across different markets, price points, and loan structures. For a complete investment analysis, combine cap rate with cash-on-cash return (which accounts for financing) and rental yield calculations.
The Cap Rate Formula
Cap rate is calculated using two key figures:
Cap Rate = (Net Operating Income / Purchase Price) x 100
NOI = Annual Gross Rent - Operating Expenses
Operating expenses include property taxes, insurance, maintenance, property management fees (typically 8-12% of gross rent), vacancy allowance (usually 5-10%), and owner-paid utilities. Mortgage payments are explicitly excluded from the NOI calculation.
Worked example: A rental property with annual gross rent of $36,000 and operating expenses of $12,000 has an NOI of $24,000. If the purchase price is $300,000, the cap rate = ($24,000 / $300,000) x 100 = 8.0%. The GRM = $300,000 / $36,000 = 8.3.
Key Terms You Should Know
- NOI (Net Operating Income): Annual rental income minus all operating expenses, excluding debt service. The core profitability measure for investment properties.
- GRM (Gross Rent Multiplier): Purchase price divided by annual gross rent. A quick screening metric where lower values indicate better relative value. Typical range: 6-15.
- Cash-on-Cash Return: Annual pre-tax cash flow divided by total cash invested, accounting for financing. Measures return on your actual money invested, not total property value.
- Vacancy Rate: The percentage of time a property sits unoccupied. The national average is approximately 6-7%, but varies widely by market and property type.
- Operating Expense Ratio: Total operating expenses divided by gross rent. Typical range: 35-45% for residential rentals, 40-55% for commercial properties.
Cap Rates by Market and Property Type
| Property Type / Market | Cap Rate Range | Risk Level |
|---|---|---|
| Class A multifamily (gateway cities) | 3.5% - 5.0% | Low |
| Single-family rental (suburban) | 5.0% - 7.0% | Low-Medium |
| Small multifamily (2-4 units) | 5.5% - 8.0% | Medium |
| Value-add multifamily | 6.0% - 9.0% | Medium-High |
| Retail / Commercial | 6.0% - 10.0% | Medium-High |
| High-yield tertiary markets | 8.0% - 12.0% | High |
Source: Estimates based on NAR and CBRE 2025 market data. Cap rates fluctuate with interest rates and local market conditions.
Practical Cap Rate Examples
Example 1 - Single-family rental in the Midwest: Purchase price $200,000. Monthly rent $1,800 ($21,600/year). Operating expenses: taxes $3,600, insurance $1,200, maintenance $2,400, management $2,160 (10%), vacancy $1,080 (5%) = $10,440 total. NOI = $21,600 - $10,440 = $11,160. Cap rate = $11,160 / $200,000 = 5.58%.
Example 2 - Duplex in a growing market: Purchase price $350,000. Two units at $1,500/month each ($36,000/year). Operating expenses: $15,000 total. NOI = $21,000. Cap rate = $21,000 / $350,000 = 6.0%. With a 25% down payment ($87,500) and a mortgage at 6.5%, the cash-on-cash return would be approximately 7.8%. Use our mortgage calculator for detailed financing analysis.
Example 3 - Value-add apartment building: Purchase price $500,000. Current rent roll $48,000/year with potential to increase to $60,000 after renovations. Current NOI = $48,000 - $20,000 = $28,000. Current cap rate = 5.6%. Post-renovation NOI = $60,000 - $22,000 = $38,000. If the market cap rate is 6%, the property's value becomes $38,000 / 0.06 = $633,333, representing $133,333 in created equity.
Tips for Using Cap Rate in Investment Decisions
- Compare within the same market: Cap rates vary dramatically between markets. A 5% cap rate in San Francisco and a 5% cap rate in Memphis represent very different risk profiles and appreciation potential.
- Verify the NOI independently: Seller-provided NOI often understates expenses. Always verify property taxes, insurance quotes, and maintenance costs before relying on the stated cap rate.
- Account for realistic vacancy: Use 5-10% vacancy allowance even if the property is currently fully occupied. Markets can shift, and turnover costs (cleaning, repairs, lost rent) add up.
- Consider the interest rate environment: Cap rates tend to move with interest rates. When the Federal Reserve raises rates, cap rates generally expand (prices fall), creating potential buying opportunities.
- Do not rely on cap rate alone: Always analyze cash-on-cash return, internal rate of return (IRR), and appreciation potential alongside cap rate. Use our rental property calculator for comprehensive analysis.
Frequently Asked Questions
What is a good cap rate for rental property?
A cap rate of 5-7% is considered average for most US markets in 2025-2026. Above 7% is generally good, while above 10% is excellent but may indicate higher risk such as challenging tenants, deferred maintenance, or declining neighborhoods. Cap rates below 4% are common in expensive coastal markets like San Francisco, New York, and Los Angeles, where investors accept lower yields for appreciation potential. NAR data shows the national average multifamily cap rate was approximately 5.5% in 2025.
Does cap rate include mortgage payments?
No, cap rate uses Net Operating Income (NOI), which explicitly excludes debt service (mortgage payments). This is by design, as it allows investors to compare properties regardless of financing structure. An all-cash buyer and a leveraged buyer looking at the same property see the same cap rate. To evaluate returns including financing, use the cash-on-cash return metric, which divides annual pre-tax cash flow (after mortgage payments) by total cash invested.
How do I calculate NOI for a rental property?
NOI equals annual gross rental income minus all operating expenses. Operating expenses include property taxes, insurance, maintenance and repairs (budget 1-2% of property value annually), property management fees (8-12% of gross rent), vacancy allowance (5-10%), and owner-paid utilities. NOI does not include mortgage payments, capital expenditures, or depreciation. For a property with $36,000 gross rent and $12,000 in expenses, NOI is $24,000.
Why do expensive areas have lower cap rates?
Properties in high-demand areas command lower cap rates because investors accept lower current yields in exchange for greater perceived safety, stronger appreciation potential, and higher-quality tenants. A 4% cap rate in Manhattan reflects confidence in long-term value growth, while a 10% cap rate in a rural market reflects higher risk of vacancy, tenant issues, and slower appreciation. This risk-return tradeoff is fundamental to real estate investment theory.
How do rising interest rates affect cap rates?
Rising interest rates generally push cap rates higher (and property values lower) because investors demand higher returns to compensate for more expensive financing. When the Federal Reserve raised rates from 0.25% to 5.50% in 2022-2023, average multifamily cap rates expanded by approximately 100-150 basis points. However, the relationship is not perfectly linear, as strong rental demand and limited supply can partially offset rate increases in high-demand markets.
What is the difference between cap rate and ROI?
Cap rate measures current income return based on property value (NOI / Price), while ROI (Return on Investment) considers total returns including appreciation, tax benefits, and equity paydown over a holding period. A property with a 6% cap rate might have a total annual ROI of 12-15% when factoring in 3-5% annual appreciation, mortgage principal paydown, and tax deductions. Use our ROI calculator for comprehensive return analysis.