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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Understanding Cap Rate
The capitalization rate (cap rate) is the most fundamental metric for evaluating investment properties. It is calculated by dividing the Net Operating Income (NOI) by the purchase price: Cap Rate = NOI / Purchase Price x 100. NOI is annual gross rent minus operating expenses (property taxes, insurance, maintenance, management fees), excluding mortgage payments.
A higher cap rate indicates a potentially higher return but often comes with higher risk. Properties in prime locations typically have lower cap rates (3-5%) because they are considered safer investments. Properties in less desirable areas may have higher cap rates (8-12%) to compensate for additional risk. The average cap rate across the US is roughly 5-7%.
The Gross Rent Multiplier (GRM) is another quick metric: Purchase Price divided by Annual Gross Rent. A lower GRM suggests a better deal. While cap rate and GRM are useful screening tools, a complete investment analysis should also consider cash-on-cash return, appreciation potential, financing terms, and local market conditions.
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. Above 7% is generally good, and above 10% is excellent but may indicate higher risk. Cap rates below 4% are common in expensive coastal markets.
Does cap rate include mortgage payments?
No, cap rate uses NOI which does not include debt service (mortgage payments). This makes it useful for comparing properties regardless of financing structure. Cash-on-cash return accounts for financing.
How do I calculate NOI?
NOI = Gross Rental Income - Operating Expenses. Operating expenses include property taxes, insurance, maintenance, property management fees, vacancy allowance, and utilities paid by the owner. It does not include mortgage payments.
Why do expensive areas have lower cap rates?
Properties in high-demand areas have lower cap rates because investors accept lower yields for greater perceived safety, appreciation potential, and tenant quality. These markets are considered lower risk.