Capitalization rate is the single number real estate investors use to compare rental properties at a glance. Enter the purchase price, rent, vacancy, and operating costs to get your net operating income (NOI), cap rate, and annual cash return — the fast way to tell a good deal from a money pit.
Capitalization rate & NOI
*Before any mortgage / debt service. Cap rate is an unleveraged metric.
Cap rate answers a deceptively simple question: if you paid cash for this property, what annual return would the income alone give you? You calculate it by dividing net operating income — all the rent you collect after vacancy and operating costs, but before any mortgage — by the property's price. A $350,000 building throwing off $22,000 of NOI has a cap rate of about 6.3%. That percentage lets you line up wildly different properties side by side and judge them on the same yardstick, the same way a stock investor uses a dividend yield.
What counts as a "good" cap rate depends entirely on the market and your appetite for risk. In expensive, stable metros, prime properties might trade at 4%–5% caps because buyers will accept a lower yield for safety and appreciation. In smaller or riskier markets, you might see 8%–10% to compensate for slower growth and more headaches. There's an inverse relationship worth remembering: lower cap rates usually signal pricier, lower-risk assets, while high cap rates often come with more work, more vacancy risk, or softer demand. Neither is automatically better — they're just different bets.
The one trap to avoid is treating optimistic numbers as gospel. The honest NOI includes a realistic vacancy allowance (rarely zero) and every real operating cost: property taxes, insurance, maintenance, property management, and reserves for the roof and HVAC that will eventually fail. This calculator bakes vacancy and expenses in for you and even shows your operating expense ratio, which for well-run residential rentals typically lands somewhere between 35% and 50% of effective income. Just remember cap rate ignores your mortgage — for the leveraged return on your actual cash, pair it with a rental property or cash-on-cash analysis.
Cap rate = net operating income divided by value. It's the unleveraged yield a cash buyer would earn.
Pricey stable markets show low caps; higher caps usually mean more risk or more work. Context is everything.
Include vacancy, management, and reserves. A cap rate built on rosy numbers will mislead you on closing day.