What Is a Good Cap Rate for a Rental Property?

Cap rate gets thrown around a lot, and it's often used wrong. Here's what it actually measures, and why it's different from cash-on-cash return.

The formula

Cap Rate = Annual Net Operating Income / Purchase Price

Net operating income (NOI) is rent minus operating expenses: taxes, insurance, maintenance, property management, vacancy. It does not include your mortgage payment. That's the whole point of cap rate. It measures how the property performs on its own, as if you bought it in cash.

Why that matters

Cash-on-cash return changes depending on how you finance the deal. Put more down, your cash-on-cash goes down but your risk goes down too. Cap rate doesn't move with financing at all. It's the same number whether you pay cash or put 5% down. That makes it useful for comparing properties or markets on equal footing, separate from how any one buyer chooses to finance.

A quick example

A property costs $250,000. Rent brings in $28,000 a year. After taxes, insurance, maintenance, management, and a vacancy allowance, NOI comes out to $15,000.

$15,000 / $250,000 = 6% cap rate

What counts as "good"

It depends entirely on the market. In expensive coastal metros, 3-4% cap rates are common and considered normal, because buyers are paying for appreciation, not cash flow. In cash-flow-focused Midwest and Southern markets, 6-9% is a more typical target range. There's no single right number. The right question is whether the cap rate is good relative to that specific market, not relative to some number you read once online.

The trap: a "good" cap rate can still lose you money

This is the part that catches first-time investors off guard. Take that same $250,000 property with a 6% cap rate. Finance it with 20% down at a 7% rate, and here's what actually happens once real numbers go in:

NOI (before mortgage):        $15,000/year
Mortgage payment (7%, 30yr):  $15,967/year on the $200,000 loan
Cash flow after financing:      -$967/year

A perfectly respectable 6% cap rate turns into negative cash flow, because the interest rate (7%) is higher than the cap rate (6%). This is one of the most useful mental shortcuts in real estate investing: when your interest rate is higher than the property's cap rate, leverage works against you. Every dollar you borrow costs more than the property earns. The property isn't a bad property, the deal at that price and that rate is a bad deal.

The reverse is also true. If that same property had an 8% cap rate instead of 6%, it would clear a 7% interest rate with room to spare, and financing would boost your return instead of eating it. This is exactly why cap rate and cash-on-cash return have to be checked together, not one instead of the other.

Cap rate vs. cash-on-cash return vs. the 1% rule

Three numbers, three different jobs:

• Cap rate tells you how the property performs unfinanced. Best for comparing properties or markets on equal footing.
• Cash-on-cash return tells you how your specific financed deal performs. Best for deciding if a deal works for you, with your actual loan terms.
• The 1% rule is a fast, rough filter (does monthly rent hit roughly 1% of price) for deciding whether something's even worth running the real numbers on. It's not a substitute for either of the other two.

Use the 1% rule to screen fast, cap rate to compare properties or markets, and cash-on-cash return to decide whether the actual deal, with your actual financing, is one you'd put money into.

Where it falls short

Cap rate ignores your financing entirely, which means it also ignores whether the deal actually puts money in your pocket each month. A property can have a great cap rate and still have negative cash flow if you financed it with a high rate and a small down payment, and (less intuitively) a property with a mediocre cap rate can still cash flow well if the financing is cheap enough. Cap rate tells you if the property itself is priced well. It doesn't tell you if the deal works for you specifically. For that, you need cash-on-cash return too.

Frequently asked questions

Is a higher cap rate always better? Not necessarily. An unusually high cap rate for the area can be a sign of higher risk (a rougher neighborhood, older systems needing replacement soon, or an unrealistic expense estimate) rather than a genuinely better deal. Compare it against similar properties in the same market, not against a number from a different city.

Why do cap rates differ so much by city? Cap rate is priced by what buyers in that market are willing to accept, which reflects how much of the return they expect to come from appreciation versus cash flow. Markets with strong long-term appreciation expectations tend to trade at lower cap rates (buyers accept less cash flow, betting on the equity gain); markets valued mainly for their rent tend to trade at higher cap rates.

Can I use cap rate on a property I'm financing with a mortgage? Yes, cap rate is calculated the same way regardless of how you plan to pay for the property, it's deliberately financing-agnostic. Just don't stop there. Run cash-on-cash return next using your actual loan terms before deciding the deal works.

We calculate both automatically for every listing we check, every night, so you're never picking just one number and missing what the other one is telling you.