Cap Rate Guide: What It Is, How to Calculate It, and What Counts as Good

If you only learn one metric before buying an investment property, make it the capitalization rate. It’s the number professional investors quote to each other, the basis on which commercial property is priced, and the fastest way to spot a deal that only looks good in the listing photos.

The formula

Cap rate is net operating income divided by property value, expressed as a percentage. A property producing $18,000 of NOI and priced at $320,000 has a cap rate of about 5.6%.

Two things make this metric powerful. First, it ignores financing: whether a buyer pays cash or borrows 80%, the property itself earns the same income, so cap rates let you compare properties — and compare against other investments — on equal footing. Second, it works in both directions: if similar buildings in a neighborhood trade at a 6% cap rate, a property with $24,000 of NOI is worth roughly $400,000. Investors use this constantly to sanity-check asking prices.

Everything depends on an honest NOI

Net operating income is annual rental income minus operating expenses — before any mortgage payments. The expense list is where deals are won and lost:

• Property taxes (verify the actual rate with the Property Tax Calculator — and note taxes often reset upward after a sale reassessment)
• Insurance
• Maintenance and repairs
• Property management, typically 8–10% of rent even if you self-manage today
• Utilities and services you pay as the landlord
• A vacancy allowance — 5–8% of rent is a common assumption

What does not belong in NOI: mortgage payments, depreciation, and capital expenditures like a roof replacement (budget those separately).

Seller marketing packages routinely quote a “pro forma” cap rate built on zero vacancy, no management fee, and last decade’s tax bill. Rebuild the NOI yourself from real numbers before believing any advertised rate. The Cap Rate Calculator makes the final division trivial — the work is in the inputs.

What counts as a good cap rate?

There is no universal answer, only a trade-off. Most US residential investment property trades somewhere between 4% and 10%:

• Lower cap rates (4–6%) cluster in expensive, supply-constrained markets. You accept less current income in exchange for stability and, historically, stronger appreciation.
• Higher cap rates (8%+) pay more income per dollar invested, but usually carry more risk: softer tenant demand, older buildings, heavier maintenance, or declining areas.

A “great” 9% cap rate in a market where everything trades at 9% is just… the market. Compare against recent sales of similar properties in the same submarket, not a national average.

Cap rate vs gross yield: use both, in order

Gross rental yield — annual rent over price, no expenses — is the faster screen. Use the Rental Yield Calculator to scan a dozen listings in minutes, then build a real NOI and compute cap rates for the two or three finalists. Yield gets you a shortlist; cap rate gets you a decision.