Cap Rate Calculator

How to calculate cap rate

The cap rate formula is simple: Cap Rate = Net Operating Income / Property Value, expressed as a percentage. Work it in three steps:

1. Find gross annual income. Add up all the rent and other income the property collects in a year.
2. Subtract operating expenses to get NOI. Take out property taxes, insurance, repairs and maintenance, property management, utilities you pay, and a vacancy allowance. Do not subtract mortgage payments or depreciation.
3. Divide NOI by the property value. A $300,000 property with $18,000 of NOI has a 6.0% cap rate. The calculator above does this instantly and also shows your cash-on-cash return.

A worked example

Take a duplex listed at $350,000 that rents for $30,000 a year. Budget 5 percent for vacancy and you are working with $28,500 of effective gross income. Now subtract the operating costs: $4,000 in property taxes, $1,500 for insurance, $2,000 for repairs, $2,400 for management, and $500 of everything else. That is $10,400 out, which leaves $18,100 of NOI.

Divide $18,100 by $350,000 and the cap rate is 5.17 percent. Whether that is good news depends entirely on what similar duplexes in that neighborhood actually sold for. If comparable buildings trade at a 6 percent cap rate, the same $18,100 of NOI only supports a value near $301,700, and the asking price is ahead of the market.

What is NOI (net operating income)?

NOI is what a property produces after operating expenses but before financing and taxes. It is the numerator in the cap rate formula and the cleanest way to compare two buildings, because it strips out how each one is paid for.

Four things people wrongly subtract from NOI: mortgage principal and interest, depreciation, capital improvements like a new roof, and income taxes. Depreciation is a paper deduction that lowers your tax bill without touching the cash the building generates, so it has no place in NOI. Leave a capital expense in and you will understate NOI and talk yourself out of a fine deal.

The other common mistake is running the numbers at 100 percent occupancy. No rental stays full forever. Subtract a vacancy allowance before you subtract anything else, or your cap rate will flatter the property. If you are still working out what the property will collect in the first place, start with the rental income calculator.

What is a good cap rate?

There is no universal good number, and anyone who gives you one without asking where the property is has skipped the only question that matters. Cap rate prices risk, not quality. A low cap rate usually means buyers see safe, durable income and have bid the price up. A high cap rate usually means they want more income per dollar to take the property on.

The rough bands below are orientation, not benchmarks:

• 3% to 5%: high-cost, high-demand urban markets where prices are bid up.
• 6% to 8%: many stable suburban and secondary markets, a common buy-and-hold target.
• 9% and up: higher-yield or higher-risk markets, older properties, or weaker rent growth.

Do not lean on those ranges to make a decision. A 5 percent cap rate can be a win in an expensive coastal market and a poor trade three states away where the same building type changes hands at 8 percent. Get real numbers: recent comparable sales, a broker's opinion of value, or an appraisal. Then judge the property against its own submarket and asset class.

Why cap rates vary by property type

Buyers are not really pricing the building. They are pricing how reliable and how durable the income stream is, and different asset classes score very differently on that.

Long leases signed by creditworthy tenants in a market with steady demand produce income you can forecast years out, so buyers accept less of it per dollar spent and the cap rate compresses. Short leases, high turnover, heavy physical wear, thin resale demand, or a tenant base that struggles in a downturn all push the other way: buyers want more income up front to compensate, and the cap rate rises. Property age and deferred maintenance do the same thing, because a building that will need capital soon has a shakier claim on the NOI you are looking at today.

This is why cross-asset comparisons mislead. A self-storage cap rate is not a fair yardstick for a single-family rental, and neither one tells you much about an office building. Compare like with like, in the same submarket, from recent sales. If you are analyzing commercial rather than residential property, the commercial side of the portfolio works the same way, but the comp set is different.

What moves cap rates

Three forces do most of the work.

• Interest rates. When borrowing gets more expensive, a deal has to throw off more income to still make sense, so buyers bid less for the same NOI and cap rates drift up. They do not move in lockstep with the Fed and they do not reprice overnight, but the pull is in the same direction.
• NOI itself. Rent growth, expense creep, and vacancy all change the numerator. This is the part you actually control.
• Who else wants the property. Capital chasing a market compresses cap rates. Capital leaving expands them, regardless of how your building is performing.

Because value equals NOI divided by cap rate, the second and third forces can drag in opposite directions. You can raise rents, hold expenses flat, grow NOI, and still watch your valuation fall because the market repriced around you. That is not a failure of the property. It is the denominator moving.

Where cap rate misleads you

Cap rate is a single snapshot ratio, and it is silent on most of what determines whether a deal works.

• It ignores your mortgage entirely. Two investors buying the same building at the same cap rate can have completely different outcomes depending on their loan. Run the mortgage calculator and the cash-on-cash return calculator before you decide.
• It says nothing about appreciation. The lowest cap rates often sit in the markets with the strongest long-run price growth. Judging on cap rate alone systematically steers you away from them.
• It is only as honest as the NOI. A seller's pro forma with optimistic rents and a thin repair budget will produce a beautiful cap rate. Rebuild NOI from actual leases and actual expenses.
• It assumes you know the value. For a property that is not currently for sale, the denominator is an estimate, and a stale purchase price is not the same thing as today's market value.
• It flattens capital spending. Two buildings can post identical NOI while one needs $60,000 of roof and HVAC work in the next three years.
• It is a one-year picture. It does not know that a below-market lease rolls next year, or that a large tenant is leaving.

Cap rate is a screening tool. It is very good at telling you which properties are worth a closer look and which are priced oddly for their market. It is not the number you buy on. Pair it with real cash flow analysis.

Cap rate vs the other numbers

Each metric answers a different question, and using the wrong one is how people talk themselves into bad deals.

• Cap rate asks: how is this property priced relative to the income it produces, ignoring financing? Best for comparing properties against each other and against the market.
• Cash-on-cash return asks: what does my actual cash earn in year one, after the mortgage? Best for deciding whether this deal beats what your money could do elsewhere.
• Total ROI asks: what do I earn across the whole hold, counting principal paydown, appreciation, and tax benefits? Broadest, and the most assumption-dependent.
• Gross rent multiplier asks: how many years of gross rent equals the price? Fast, crude, and blind to expenses, which is exactly why it should never be your last check.
• Yield asks: what do I earn over a holding period, allowing for rent growth and the eventual sale? Cap rate is a snapshot of today. Yield is the whole film.

How to improve a property's cap rate

You cannot argue the market into a different cap rate, but you own the numerator. Raise NOI and both the yield on your cost basis and the resale value go up together.

• Close the gap to market rent. Long-tenured tenants often sit well below market. Every $100 a month you recover is $1,200 of annual NOI.
• Add income that is not rent. Parking, storage, pet fees, and laundry all land in NOI.
• Cut recurring expenses, not maintenance. Re-shop insurance, appeal the tax assessment, and renegotiate management. Deferring repairs raises NOI on paper and destroys value in practice, and a buyer's inspector will find it.
• Attack vacancy and turnover. Every empty month is lost income you never get back, and turnover carries make-ready costs on top.

Run the math before you spend. At a 6 percent market cap rate, $1,000 of extra annual NOI supports roughly $16,700 of extra value, so a $5,000 improvement that adds $1,000 a year to NOI pays for itself several times over at sale. If you do sell, a 1031 exchange can defer the capital gains tax on that gain.

Cap rate vs cash-on-cash return

Cap rate ignores financing. Cash-on-cash return divides annual pre-tax cash flow by the cash you actually put in, so it does reflect your mortgage. Cap rate tells you how the asset performs; cash-on-cash tells you how your investment performs. A property can post a healthy cap rate and still return very little on your cash if the loan is expensive.

This page calculates both. Once you own the property, SealedFolio keeps them current across the whole portfolio, with no cloud and no account. See how it works.

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