THE SHORT ANSWER
Capitalization rate, or cap rate, is annual net operating income divided by property price or value, expressed as a percentage. It compares property income before financing with the amount paid or the value being considered. Cap rate is neither a guaranteed yield nor a complete measure of investment performance.
TRY THE MATH
Cap rate calculator
Hypothetical example values. Replace them with your own assumptions. Nothing is saved or sent.
An educational calculation, not a property valuation or financing decision. Definitions and lender adjustments can differ. Check the guide’s assumptions and limitations.
The cap-rate formula
Cap rate = annual NOI ÷ property price or value × 100. Label the denominator: purchase-price cap rate and an estimate based on today's value answer different questions. Also label whether NOI is historical, current annualized, or projected.
For a hypothetical $2,000,000 property with $120,000 annual NOI, cap rate is $120,000 ÷ $2,000,000 = 6%. Loan payments do not enter that calculation. Two buyers using different loans would calculate the same cap rate if their NOI and price assumptions match.
What is a good cap rate?
There is no universal good cap rate. Useful comparisons consider property type, location, condition, lease quality, growth assumptions, and the date of the evidence. A higher figure can reflect a lower price, stronger income, or risks a buyer needs to investigate.
Compare like with like. A quoted stabilized cap rate may assume future occupancy or renovations, while a trailing cap rate reflects an earlier operating period. Do not rank those figures as though they describe the same income stream.
How cap rates affect a valuation exercise
Rearranging the formula gives value = NOI ÷ cap rate. With hypothetical NOI of $120,000, a 6% assumption implies $2,000,000. A 7% assumption implies about $1,714,286. This is arithmetic sensitivity, not evidence that either rate fits a particular market.
Direct capitalization works best when the income being capitalized reasonably represents stabilized operations. If substantial lease-up, redevelopment, or uneven capital spending lies ahead, a year-by-year model can expose information that a single ratio misses.
Cap rate versus cash-on-cash return
Cap rate examines property income before financing. Cash-on-cash return examines a defined period's cash flow relative to cash invested, so borrowing and capital funding affect it. Neither captures every future dollar, tax effect, or risk.
- Verify NOI before comparing advertised cap rates.
- Check whether major repairs sit outside the income figure.
- Use current local evidence when selecting a valuation assumption.
- Model sale costs and loan payoff separately when estimating sale proceeds.
Common questions
Is a higher cap rate always better?
No. The difference may reflect condition, location, tenant risk, or income assumptions. Investigate why the rate differs.
Does cap rate include appreciation?
No. It relates an annual income measure to price or value. Future price changes require separate assumptions.
Sources & further reading
Educational content from Real Estate 101. Updated 2026-09-05. Refer to the original sources and your professional advisers for transaction-specific requirements.