Cap Rate Calculator

Calculating cap rate step by step

The cap rate formula is simple: Cap Rate = Net Operating Income / Property Value, expressed as a percentage. SealedFolio's calculator above runs all three of these steps at once, but they are worth doing by hand the first time so you can see where a number goes wrong:

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.

How to calculate cap rate from monthly rent

Most landlords know their rent as a monthly figure, and the cap rate formula wants an annual one, so SealedFolio's calculator asks for gross annual rent. Getting there takes two moves that people routinely collapse into one, which is where the arithmetic goes wrong.

1. Annualize the rent. Monthly rent multiplied by 12. A unit at $5,200 a month collects $62,400 a year.
2. Take out vacancy, then operating expenses. At a 5 percent vacancy allowance that $62,400 becomes $59,280 of effective gross income. Subtract $19,280 of taxes, insurance, repairs, and management and you are left with $40,000 of NOI.
3. Divide by the price, or by the market cap rate. $40,000 of NOI on a $600,000 asking price is a 6.67 percent cap rate. Working the other way, $40,000 at a 6 percent market cap rate implies a value of about $666,700.

The trap is dividing gross rent straight into the price. Do that here and the $62,400 against $666,700 reads as a 9.4 percent cap rate, more than half again as good as the property really is, because every operating cost has quietly vanished. Rent is revenue. NOI is what survives the expenses. If you are still assembling the income side, the rental income calculator builds gross rent and NOI from the unit level up, and the cash flow calculator carries it through to what actually reaches your account.

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. For a property you already own, the expense categories here mirror what landlords report on Schedule E, so last year's return is the fastest source of honest numbers. The Schedule E calculator breaks those categories out line by line.

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.

What a 3, 6, or 10 percent cap rate actually means

The percentage gets easier to judge once you translate it into dollars and years. Cap rate is the NOI a property produces per dollar of price, which also tells you roughly how many years of today's NOI it would take to add up to the purchase price, before any rent growth, appreciation, or financing.

• A 3 percent cap rate means $3 of NOI per $100 of price, about 33 years of current income to cover the purchase. Buyers who accept that are betting on rent growth and appreciation, not on the income in front of them today.
• A 6 percent cap rate means $6 per $100, roughly 17 years of NOI. This is the zone where the income itself starts to carry the investment case rather than the hope of a higher resale.
• A 9 or 10 percent cap rate means $9 or $10 per $100, about 10 to 11 years of NOI. Income that cheap usually has a reason attached: more risk, an older building, a thinner resale market, or a pro forma the market does not believe.

None of these readings makes a deal good or bad on its own. A 10 percent cap rate with honest numbers and a solid tenant can outperform a trophy building, and a 4 percent cap rate in a growing market can work out well over a long hold. The number tells you how the market prices the income stream. The decision still needs comps, an inspection, and a hard look at the leases.

What is a 7.5 percent cap rate?

A 7.5 percent cap rate means the property produces $7.50 of net operating income for every $100 of price. Run it through SealedFolio's cap rate calculator in either direction and the arithmetic is the same: $75,000 of NOI supports a $1,000,000 value, and a $400,000 property at 7.5 percent has to earn $30,000. In years, it would take about 13 years of today's NOI to add up to the purchase price, before any rent growth, appreciation, or financing.

In most residential and small multifamily markets 7.5 percent sits in the income-first half of the range, above the low cap rates paid for coastal and supply constrained property and below the levels that usually signal a distressed asset or a shaky rent roll. That is orientation, not a verdict. What settles it is the comp set: if similar buildings in the same submarket sold at 6.5 percent, a 7.5 percent listing is cheap for a reason worth finding, and if they sold at 9 percent, it is expensive.

What is the 7 percent rule in real estate?

There is no single agreed 7 percent rule in real estate, which is exactly why the phrase generates so much confusion around cap rate. Investors use it in at least two unrelated ways. Some mean a 7 percent cap rate floor: a quick screen that discards any rental priced below that yield before they bother underwriting it. Others mean setting aside 7 percent of collected rent for repairs and capital reserves, which is a budgeting habit and has nothing to do with valuation.

It also gets mixed up with the 1 percent rule, which asks whether monthly rent reaches 1 percent of the purchase price. That one is a gross rent test, so it ignores taxes, insurance, and vacancy entirely, and two properties that both clear it can have very different cap rates. None of these shortcuts is a valuation method. Run the actual cap rate on the calculator above, then compare it to real sales in the same submarket. If you are early enough that rules of thumb still appeal, the guide to buying your first rental property walks through the numbers that do the work instead.

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.

Cap rate compression and cap rate expansion

Brokers describe those market swings in cap rate as compression and expansion, and both are worth being able to price. Compression is cap rates falling, which raises values: a building with $30,000 of NOI moving from a 7 percent to a 6 percent market cap rate goes from $428,571 to $500,000, a gain of $71,429 with no change to the rent roll. Expansion is the reverse, and it is the one that catches owners out. That same $30,000 of NOI repricing from 6 percent to 7 percent takes $71,429 of value back off the table.

Two practical consequences. If you are underwriting a hold, do not assume you exit at the cap rate you bought at, since underwriting a slightly higher exit cap rate is the cheapest insurance against a repriced market. And if your valuation moved this year, work out how much of the move was NOI and how much was the cap rate before you credit or blame the property. The sensitivity readout in the reverse calculator above shows that split for whatever numbers you enter.

The Gordon model: cap rate as required return minus growth

There is a tidier way to think about where a cap rate comes from, borrowed from the Gordon growth model used to value dividend paying stocks. It treats cap rate as the return a buyer demands minus the growth they expect in the income stream. If investors want a 9 percent total return and expect NOI to grow 3 percent a year, they will pay a cap rate near 6 percent. That single line explains most of what the bands and the market commentary are circling: markets where buyers expect strong rent growth trade at lower cap rates, not because the income is better today but because it is expected to be better tomorrow. It also explains why cap rates move when interest rates do, since the required return goes up with the cost of money.

What investors actually use cap rate for

Cap rate earns its place by being fast and financing-blind. In practice it does a few jobs well:

• Screening listings. Run ten properties through the calculator in an afternoon and you know which three deserve a full underwrite.
• Comparing properties. Same submarket, same asset class, different prices and rents. Cap rate puts them on one scale.
• Sanity checking an asking price. If a listing's cap rate sits far from what similar buildings recently sold at, either the price is off or the pro forma is.
• Pricing a sale. Sellers and brokers work backward from NOI and the market cap rate to set an asking price, the same math as the reverse calculator above.
• Reading a market. Rising cap rates in a submarket mean buyers want more income per dollar. That tells you something rent trends alone will not.

There are also deals where cap rate is the wrong tool. Skip it for a fix and flip, where the return comes from the resale rather than the income. Skip it for a vacant building or a gut renovation, because there is no stable NOI to divide. And be careful with short-term rentals, where income swings by season and a single year of NOI can mislead in either direction.

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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