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What is Cap Rate? The Complete Guide

Learn how to calculate and use capitalization rate to evaluate rental property investments like a pro.

Quick Answer

Cap rate (capitalization rate) is a real estate metric calculated as Net Operating Income ÷ Property Value × 100. It measures the unlevered return on a rental property. A cap rate of 4–6% is typical in premium markets; 6–8% in stable markets; 8%+ in higher-risk emerging markets.

Cap Rate Definition

Cap Rate (Capitalization Rate) is a metric that measures the rate of return on a real estate investment based on the income the property generates, independent of how it's financed.

Cap rate is one of the most important metrics for real estate investors because it allows you to quickly compare properties across different markets and price points. Unlike cash-on-cash return, cap rate doesn't factor in your financing terms, making it a "pure" measure of the property's income-generating potential.

Think of cap rate as the property's unlevered yield – the return you'd get if you paid all cash for the property.

Cap Rate Formula

Cap Rate = (NOI / Purchase Price) × 100

Where NOI = Net Operating Income

Understanding NOI

NOI = Gross Rental Income - Vacancy Loss - Operating Expenses

Operating expenses include:

  • Property taxes
  • Insurance
  • Maintenance and repairs
  • Property management fees
  • Utilities (if landlord-paid)
  • HOA fees (if applicable)

Important: NOI does NOT include mortgage payments, principal, or interest. Cap rate measures property performance independent of financing.

What is a Good Cap Rate?

The "right" cap rate depends on the market, property type, and your investment goals. Here's a general guide:

4-6% Cap Rate: Low (Premium Markets)

Common in expensive metros (NYC, SF, LA). Lower cash flow but strong appreciation potential and stability. Best for long-term wealth building.

6-8% Cap Rate: Moderate (Balanced)

Found in stable secondary markets. Good balance of cash flow and appreciation. Ideal for most buy-and-hold investors.

8-10%+ Cap Rate: High (Cash Flow Markets)

Found in emerging markets or rural areas. Higher cash flow but potentially less appreciation and more risk. Great for immediate income.

Cap Rate Example

Sample Property Analysis:

Purchase Price

$200,000

Annual Rent

$24,000

Annual Operating Expenses:

  • Property Taxes: $3,000
  • Insurance: $1,200
  • Maintenance: $2,000
  • Vacancy (8%): $1,920
  • Total Expenses: $8,120

NOI Calculation

$24,000 - $8,120 = $15,880 NOI

Cap Rate

($15,880 / $200,000) × 100 = 7.94%

Frequently Asked Questions

What is the difference between cap rate and cash-on-cash return?

Cap rate measures property return without financing (NOI/Price). Cash-on-cash return measures your actual cash return based on cash invested, including mortgage payments. Use cap rate to compare properties; use cash-on-cash to evaluate your actual returns.

Can cap rate be negative?

Yes, if operating expenses exceed rental income, NOI becomes negative, resulting in a negative cap rate. This indicates the property loses money operationally and should be avoided for investment purposes.

Should I use cap rate for house flips?

No. Cap rate is for income-producing rental properties. For flips, use ROI, profit margin, and the 70% rule. Use our Flip Calculator for flip analysis.

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Last updated: June 2026