Cap rate, plainly
Net operating income divided by price. That is the whole formula. A property producing $24,000 of NOI and priced at $400,000 has a 6 per cent cap rate.
What makes it useful is what it leaves out. Cap rate contains no mortgage, no loan terms, no financing at all. Two buyers looking at the same building, one paying cash and one borrowing 75 per cent, see the identical cap rate. That is the point: it measures the property, so you can compare buildings against each other without financing noise in the way.
Running it in both directions
Forwards, from a price, it tells you the return you are being offered. Backwards, from a cap rate, it tells you what a given income stream is worth — which is how commercial property is actually valued. If similar buildings in the submarket trade at 6 per cent and yours produces $24,000 of NOI, the market says it is worth roughly $400,000, whatever the seller is asking.
This also makes cap rate a lever. NOI increased by $3,000 is worth $50,000 of value at a 6 per cent cap. Raising rents, cutting an expense line or adding an income stream does not just improve cash flow — it capitalises into the sale price. That relationship is the engine behind most commercial value-add strategies.
High cap rate is not the same as good deal
A higher cap means you are paying less per dollar of income, and the market is almost always pricing something when it does that: a weaker submarket, an older building, shorter leases, less creditworthy tenants, or a location people are leaving. Low-cap properties in strong markets are expensive because they are safer and because buyers expect rent growth to make up the difference.
Cap rates also move with interest rates. When borrowing costs rise, buyers require higher yields, cap rates expand and values fall even when NOI is unchanged. This is why a property can lose value in a year when its income went up.
Where it stops being the right tool
Cap rate is standard for commercial and multifamily property. For single-family rentals it is used less, partly because those homes are priced against owner-occupier comparables rather than against their income, so the cap rate the market will pay is not necessarily the cap rate the income justifies.
It also says nothing about your actual return, because it excludes your financing. For that, cash-on-cash return is the number you want. Cap rate compares properties; cash-on-cash compares deals.
Common questions
What is a good cap rate?
It depends entirely on market, asset class and risk, and it moves with interest rates. The only useful comparison is against genuinely similar properties in the same submarket at the same time, which is why this calculator asks for a market cap rate rather than assuming one.
Does cap rate include the mortgage?
No. Net operating income is calculated before debt service, deliberately, so that the ratio describes the property rather than any particular buyer's financing. Once you add a mortgage you are measuring cash-on-cash return instead.
What expenses go into NOI?
All operating expenses: taxes, insurance, management, maintenance, utilities you pay, association dues and a vacancy allowance. Excluded are mortgage payments, depreciation, income tax and capital expenditures, though many buyers deduct a capital reserve anyway to avoid flattering the number.
Why do cap rates go up when property values fall?
Because the income sits on top of the price. If NOI holds steady and the price drops, the ratio rises. Rising interest rates push this along: buyers need higher yields to justify more expensive debt, so cap rates expand and prices adjust downward to meet them.
Can I use cap rate on a single-family rental?
You can calculate it, and it is a reasonable way to compare income across houses. But single-family homes are priced against what owner-occupiers will pay, not against their income, so the market cap rate is a weaker valuation guide than it is for apartment buildings or commercial property.