What is a cap rate?
The capitalization rate, or cap rate, is the yearly return a property would produce if you bought it entirely with cash. It lets you compare properties of different sizes and prices on equal terms because it ignores financing.
Net operating income (NOI) is gross rent plus other income, minus vacancy, minus operating expenses. Operating expenses include property taxes, insurance, repairs, management, utilities you pay and HOA dues. They do not include mortgage payments, depreciation or income taxes.
Example
A fourplex priced at $500,000 rents for $4,000 a month ($48,000 a year). After 5% vacancy ($2,400) and $16,000 of operating expenses, NOI is $29,600. The cap rate is $29,600 ÷ $500,000 = 5.92%. If you want a 7% cap rate, the most you'd pay is $29,600 ÷ 0.07 = $422,857.
What is a good cap rate?
There's no single answer. Cap rates reflect risk and growth expectations in each market:
| Cap rate | Typical situation |
|---|---|
| 3% to 5% | Prime locations in high-cost cities, new buildings, strong appreciation expected |
| 5% to 8% | Typical stabilized residential rentals in many US metros |
| 8% to 12%+ | Higher-risk areas, older properties, smaller markets, more management required |
A higher cap rate means more income per dollar of price, but usually more risk. Compare a property's cap rate with similar recent sales in the same neighborhood, not with national averages.
Cap rate vs cash on cash return
Cap rate measures the property; cash on cash return measures your investment including the loan. If your mortgage rate is higher than the cap rate, borrowing makes your cash on cash return lower than the cap rate (negative leverage). Use the cash on cash return calculator to see the effect of financing.
Frequently asked questions
Does cap rate include the mortgage?
Is a higher cap rate better?
How do I get value from a cap rate?
Should I use asking rent or actual rent?
Last reviewed: 2026-10-09