The Capitalization Rate (Cap Rate) measures the annual return on an income‐producing property. It’s calculated by dividing the property’s annual Net Operating Income (NOI) by its current market value and expressing the result as a percentage.
Include: Rent, fees, other recurring income. Exclude: Mortgage payments, depreciation, income taxes. Operating expenses—taxes, insurance, maintenance—must be deducted.
Using current market value reflects up‐to‐date pricing but can fluctuate. Purchase price shows yield on original investment. Investors often calculate both to compare yield vs. acquisition cost.
Assume annual NOI = $100,000 and market value = $1,000,000. Cap Rate = (100,000 ÷ 1,000,000) × 100% = 10%.
Higher cap rates generally indicate higher risk or less‐desirable assets. Lower cap rates imply stable, premium properties with lower yields.
Use quarterly broker surveys, MLS comps and commercial real estate reports (e.g., CBRE, JLL) to find market‐wide cap‐rate benchmarks.
Subtract a vacancy allowance and set aside reserves for major repairs or capital expenditures. Adjusted NOI yields a more conservative cap rate.
Online cap‐rate calculators and comparison tables help you input NOI, value, vacancy and reserve assumptions for instant analysis.
Purchase price: $1,200,000. Gross rent: $150,000/year. Vacancy allowance: 5%.
Compare 8.33% to market cap rates (e.g., 6–7% for similar assets). Higher yield suggests room to buy or negotiate a higher price. If your target is 9%, walk away or request price reduction.
Cap rate ignores financing structure, tax strategies and long‐term growth.
Highly leveraged deals can boost cash‐on‐cash return without changing cap rate. Market timing shifts valuations.
New builds and rehab projects may require stabilized NOI. Gross cap rates (based on gross income) differ from net cap rates (based on NOI).
All recurring income minus operating expenses; excludes debt service, depreciation, capEx.
Not necessarily—too high may signal risk, deferred maintenance or weak market demand.
Use purchase price to assess your deal yield; use market value for appraisal comparables.
Cap rate is debt‐neutral. Leverage impacts cash‐on‐cash return and IRR, not cap rate.
Check local broker surveys and MLS data. A “good” cap rate aligns with or exceeds market benchmarks for similar risk profiles.
Reduce NOI by estimated annual reserve contributions for replacement and repair to derive a conservative cap rate.
The cap rate is a foundational metric for assessing property value, comparing investments and gauging risk. By mastering cap‐rate calculations, market benchmarks and limitations, you can make data‐driven decisions—whether you’re an investor, broker, lender or homeowner.
