Cap Rate Explained: Formula, Calculator, and What’s a Good Rate
What Is Cap Rate?
Capitalization rate (cap rate) measures the annual return on a real estate investment without factoring in financing. It answers a simple question: if you paid all cash for this property, what percentage yield would you earn from its income?
The formula is straightforward:
Cap Rate = Net Operating Income (NOI) / Property Value
A property generating $50,000 in NOI and priced at $750,000 has a cap rate of 6.67%. That number tells you the unlevered yield — what the property earns on its own, regardless of how you finance it.
Cap rate strips out the noise of different loan terms, down payments, and interest rates. Two investors buying the same building with different mortgages will see different cash-on-cash returns, but the cap rate stays identical. That makes it the standard language for comparing property valuations across deals.
Think of cap rate like a bond yield. Lower cap rates mean investors accept lower returns because they perceive lower risk (or expect higher appreciation). Higher cap rates signal higher risk, weaker demand, or both.
The Cap Rate Formula Step-by-Step
Calculating cap rate takes three steps. Get the inputs right and the math is simple.
Step 1: Calculate Gross Income
Add up all rental income the property generates at full occupancy. Include base rent, parking fees, laundry income, pet rent, storage fees — every dollar the property produces.
For a 10-unit building where each unit rents for $1,200/month: $1,200 x 10 x 12 = $144,000 Gross Potential Income.
Step 2: Subtract Operating Expenses
Operating expenses include property taxes, insurance, maintenance, property management fees, utilities (owner-paid), landscaping, and administrative costs. These are the recurring costs of running the building.
What’s NOT included: mortgage payments, depreciation, income tax, and capital expenditures. These are excluded because cap rate measures the property’s performance, not the owner’s financial situation.
If operating expenses on that 10-unit building total $54,000/year:
$144,000 Gross Income – $54,000 Operating Expenses = $90,000 NOI
Read more about how to calculate NOI accurately.
Step 3: Divide NOI by Property Value
If the property is listed at $1,350,000:
$90,000 / $1,350,000 = 0.0667 = 6.67% Cap Rate
That’s it. You now know the unlevered yield on this investment. But what does 6.67% actually mean? Is that good?
What’s a Good Cap Rate?
There’s no single “good” cap rate — it depends entirely on the market, property class, and your investment goals. The range varies widely across the country.
4%-5% cap rates are typical in coastal and expensive markets like San Francisco, New York, Boston, and Seattle. These properties cost more relative to their income, but investors accept the lower yield because they expect appreciation and lower vacancy risk.
6%-8% cap rates are common in Midwest and Southern markets like Indianapolis, Memphis, Kansas City, and San Antonio. These markets offer stronger cash flow relative to purchase price, with moderate growth potential.
8%-12% cap rates appear in rural areas and Class C/D properties. The higher yield compensates for higher vacancy, more maintenance, and weaker tenant quality. A 10% cap rate sounds great until you’re dealing with constant turnover and deferred maintenance.
The relationship is inverse: lower cap rate = higher price = perceived lower risk. A 4% cap rate building isn’t better or worse than an 8% cap rate building — they serve different investment strategies.
By property class:
- Class A (newer, prime locations): 4%-5%
- Class B (good condition, decent areas): 5%-7%
- Class C (older, working-class areas): 7%-10%+
For context, the national average cap rate for multifamily properties was roughly 6.5% in 2024.
Cap Rates by Market
Here are typical cap rate ranges for major US metros. These are averages — individual deals will vary based on property condition, location within the metro, and asset class.
| Metro Area | Typical Cap Rate Range | Market Type |
|---|---|---|
| San Francisco, CA | 3.5% – 4.5% | High appreciation, low yield |
| New York, NY | 4.0% – 5.0% | High appreciation, low yield |
| Los Angeles, CA | 4.0% – 5.0% | High appreciation, low yield |
| Seattle, WA | 4.5% – 5.5% | Growth market |
| Austin, TX | 5.0% – 6.0% | Growth market |
| Phoenix, AZ | 5.5% – 6.5% | Balanced |
| Dallas, TX | 5.5% – 6.5% | Balanced |
| Indianapolis, IN | 7.0% – 8.5% | Cash flow market |
| Memphis, TN | 7.5% – 9.0% | Cash flow market |
| Cleveland, OH | 8.0% – 10.0% | High yield, value-play |
Notice the pattern: coastal gateway cities cluster at the bottom (low cap rates, high prices), while Midwest and Southern markets offer higher yields. This isn’t random — it reflects investor demand, population trends, and risk perception.
For city-by-city analysis, check the best cities to invest in real estate in 2026.
How to Use Cap Rate to Compare Deals
Cap rate works best as a comparison tool — but only when you compare properties within the same market and asset class.
Say you’re looking at two duplexes in Indianapolis:
- Property A: $180,000 purchase, $15,300 NOI → 8.5% cap rate
- Property B: $210,000 purchase, $16,800 NOI → 8.0% cap rate
Property A offers a higher cap rate, meaning more income per dollar spent. But why is it cheaper? Maybe it needs a new roof. Maybe it’s in a weaker neighborhood. Cap rate tells you the yield — you still need to figure out the why.
Don’t compare cap rates across different markets. A 6% cap rate in Austin is not the same as a 6% cap rate in Memphis. Austin’s 6% might be a fair deal in a growth market, while Memphis’s 6% could be overpriced relative to local norms. Always compare within the same market context.
Cap rate also helps you reverse-engineer property values. If you know a market trades at 7% cap rates and a property generates $70,000 NOI, the expected value is $70,000 / 0.07 = $1,000,000. If the seller is asking $1,200,000, you know it’s priced at a 5.8% cap — below market.
This approach is standard in commercial real estate appraisals. The gross rent multiplier offers a quicker (but less precise) version of the same concept.
Cap Rate Limitations
Cap rate is widely used, but it has real blind spots. Know what it doesn’t tell you.
It Ignores Financing
Cap rate assumes all-cash purchase. In practice, most investors use mortgages. A property with a 7% cap rate financed at 6.5% interest barely cash flows. The same property financed at 4% interest throws off solid returns. Cap rate doesn’t capture this difference at all. That’s where cash-on-cash return picks up.
It Doesn’t Account for Appreciation
San Francisco’s 4% cap rate looks weak on paper. But if the property appreciates 5%-8% annually, total return dwarfs a 10% cap rate property in a flat market. Cap rate only measures current income yield — not total return.
It Doesn’t Work Well for Value-Add
A vacant building has zero NOI and therefore no meaningful cap rate. A severely underperforming property will show a misleading cap rate because the current NOI doesn’t reflect its potential. For value-add deals, you need to project the stabilized NOI and calculate the cap rate on that future number.
It’s a Static Snapshot
Cap rate shows you one year of performance. It doesn’t tell you whether rents are rising or falling, whether taxes are about to spike, or whether a major employer just left the area. Always look at cap rate alongside market trends and rent growth data.
Cap Rate vs. Cash-on-Cash Return
These two metrics confuse a lot of new investors. Here’s the core difference:
- Cap rate = unlevered yield (ignores your mortgage)
- Cash-on-cash return = return on your actual invested cash (includes your mortgage)
Same property, different stories:
| Metric | All-Cash Purchase | Financed (25% Down) |
|---|---|---|
| Purchase Price | $400,000 | $400,000 |
| NOI | $28,000 | $28,000 |
| Cap Rate | 7.0% | 7.0% |
| Annual Debt Service | $0 | $19,200 |
| Pre-Tax Cash Flow | $28,000 | $8,800 |
| Total Cash Invested | $400,000 | $112,000 |
| Cash-on-Cash Return | 7.0% | 7.86% |
The cap rate is 7% regardless of financing. But with a mortgage, the cash-on-cash return rises to 7.86% because you invested less cash. This is positive leverage — the mortgage costs less than the property yields, so borrowing boosts your cash return.
If that same property had a mortgage at 8% interest, debt service would eat more of the NOI and the cash-on-cash return would drop below 7%. That’s negative leverage.
Use cap rate to evaluate the property itself. Use cash-on-cash return to evaluate the deal given your specific financing. They serve different purposes — and you need both. Learn more about structuring your first rental property deal.
Frequently Asked Questions
Is a higher cap rate always better?
No. A higher cap rate means higher yield, but it also means higher perceived risk. A 12% cap rate property often comes with problem tenants, high vacancy, deferred maintenance, or a declining neighborhood. The “best” cap rate depends on your risk tolerance and investment strategy. An investor seeking stable, long-term holdings might prefer a 5% cap rate in a strong market over a 10% cap rate in a rough area.
Can a cap rate be negative?
Technically yes, if operating expenses exceed gross income (negative NOI). This happens with severely vacant or mismanaged properties. A negative cap rate is a red flag — the property is losing money before you even make a mortgage payment.
Does cap rate work for single-family rentals?
It can, but it’s less common. Single-family homes are often valued based on comparable sales (what similar homes sell for), not income. Cap rate is most useful for multifamily and commercial properties where income drives valuation. For single-family analysis, the 1% rule is often a faster screening tool.
How often do cap rates change?
Cap rates shift with interest rates, investor demand, and market conditions. When interest rates rise, cap rates tend to rise too (prices drop). When rates fall and money is cheap, cap rates compress (prices rise). In the low-rate environment of 2020-2021, cap rates hit historic lows. The rate hikes of 2022-2023 pushed them back up.
Where can I find cap rate data for my market?
Broker reports from firms like CBRE, Marcus & Millichap, and Cushman & Wakefield publish quarterly cap rate surveys by metro and property type. For smaller deals, look at local MLS data and calculate cap rates yourself from listed prices and income. The mortgage payment calculator can help you model different scenarios once you have the numbers. Sites like LoopNet and Crexi list asking cap rates on commercial listings.
Cap rate is the single most important metric in real estate investing — and the most commonly misused. It tells you the yield, but it can’t tell you the full story. Pair it with cash-on-cash return, NOI analysis, and your own due diligence before writing any offer. A 10-minute cap rate calculation can save you from a six-figure mistake. For a broader look at getting started, read the beginner’s guide to real estate investing.
For market-by-market data on where the numbers pencil out today, see our best cities to invest in real estate breakdown.