If you’re going into real estate investing or already own a rental property, understanding how to calculate cap rate is essential. This quick yet powerful formula helps you evaluate the potential return on an income-producing property.

Whether you’re analyzing your first deal or comparing multiple opportunities, knowing how to calculate cap rate gives you a clearer picture of a property’s earning potential.

What Is a Cap Rate?

A cap rate (short for capitalization rate) is a real estate metric that shows the expected return on investment for a rental property, assuming you purchase it with cash and no financing. It is expressed as a percentage and helps investors evaluate the income potential of a property.

Cap rates are useful for:

• Determining whether a property is fairly priced
• Comparing rental properties across different markets
• Assessing the risk and return of an investment

If you want to build a rental portfolio or grow your passive income, understanding the cap rate is essential for making informed investment decisions.

Cap Rate Formula (Plus Easy Example)

Here’s the basic formula:

Let’s break that down:

• Net Operating Income (NOI): The annual income your property generates after expenses (excluding mortgage payments).
• Property Value: The current market value or purchase price of the property.

Example:

Let’s say your rental property earns $18,000 annually after expenses, and the property is valued at $300,000:

Cap Rate = $18,000 / $300,000 = 0.06 or 6%

That means you can expect a 6% return on your investment if you purchase the property in cash.

Pro Tip: Always use annual income and expenses when calculating cap rate for consistent and reliable comparisons.

Cap Rate Calculator

Want to skip the math? Use our free Cap Rate Calculator to quickly find the cap rate of any rental property. Just click the link below, enter the numbers, and the tool will do the rest.

Calculate Your Cap Rate Now

How to Calculate Cap Rate on a Rental Property (Step-by-Step)

Let’s walk through how to manually calculate cap rate using real numbers.

Step 1: Determine Your NOI

Add up your rental income, then subtract recurring expenses (repairs, insurance, taxes, etc.).

Need help with this step? Read our blog on calculating NOI

Step 2: Know the Market Value

Use comparable sales in your area or a recent appraisal to determine current value. If you’re buying, use the asking price.

Step 3: Apply the Formula

Divide the annual NOI by the property value and convert to a percentage. That’s your cap rate.

Example:

• Monthly rent: $2,000
• Annual expenses: $4,800
• NOI = ($2,000 x 12) – $4,800 = $19,200
• Market value = $320,000
• Cap Rate = $19,200 / $320,000 = 6%

What Is a Good Cap Rate? (And What It Means for You)

There’s no one-size-fits-all answer when it comes to a “good” cap rate, but according to CBRE’s H2 2024 Cap Rate Survey, a healthy range typically falls between 4% and 10%.

Typical Cap Rates by Property Type:

Property Type	Average Cap Rate
Single-family	4% – 6%
Multi-family	5% – 8%
Commercial Retail	6% – 10%

• Higher cap rates often indicate higher risk but also the potential for greater returns. These properties may be in up-and-coming areas or require more management.
• Lower cap rates typically suggest a safer, more stable investment. These properties are usually in high-demand, well-established areas with less fluctuation in income.

Cap Rate vs ROI: Key Differences Investors Should Know

Both Cap Rate and ROI (Return on Investment) are important metrics for measuring profitability, but they focus on different aspects of the investment.

Metric	Focus	Includes Financing?	Use Case
Cap Rate	Property performance	No	Compare property value vs income
ROI	Investor’s personal return	Yes	Evaluate return after all costs, including financing

When to Use Each Metric:

• Use ROI to assess the overall return on your investment, especially when you’ve financed the property or have other additional costs.
• Use Cap Rate to compare the income-generating potential of different properties, especially when you’re not factoring in financing.

Common Mistakes to Avoid When Calculating Cap Rate

Even a simple formula can go wrong if you miss the details. Here are mistakes to avoid:

• Using Gross Income Instead of NOI: Always subtract expenses to get your Net Operating Income (NOI). Gross income doesn’t give a full picture of profitability.
• Skipping Vacancy and Maintenance Reserves: Don’t forget to account for potential vacancies and ongoing maintenance costs. These can significantly impact your return.
• Using the Wrong Property Value: Make sure you’re using the current market value, not a post-renovation estimate. The property’s market value is what matters for cap rate calculation.
• Forgetting That Cap Rate Doesn’t Account for Financing: Cap rate is based on a property’s performance without considering financing costs. It reflects the income potential, not your actual investment return if you’ve taken out a loan.

When to Use Cap Rate (And When Not To)

Cap rate is most useful when:

• Comparing multiple rental properties to evaluate which offers the best potential return.
• Evaluating turnkey or stabilized investments that are already generating consistent income.
• Assessing potential yield in different markets, especially when comparing properties in various locations.

However, don’t rely solely on cap rate when:

• Purchasing a fixer-upper or value-add property, where future renovations will impact profitability.
• Analyzing short-term rentals or strategies like BRRRR (Buy, Rehab, Rent, Refinance, Repeat), as they often have fluctuating income.
• Dealing with creative financing or unique tax situations, which cap rate doesn’t account for.

Use cap rate as a starting point in your investment analysis, but always consider other factors such as property condition, financing options, and market dynamics before making your final decision.

FAQs About Cap Rate