Cap Rate: What It Is and How to Calculate It

The formula

Cap rate = Net operating income (NOI) / Purchase price

NOI is the rent you collect in a year minus the costs of running the property: property tax, insurance, repairs, vacancy and management. It leaves out the mortgage. Cap rate describes the property because the loan isn't in it.

An example

A house costs US$150,000 and brings in US$17,400 in rent a year. After property tax, insurance, vacancy, maintenance and management, about US$12,100 is left. The cap rate is US$12,100 / US$150,000, which is 8.1%.

If you paid cash, 8.1% would also be your yearly return before any appreciation. With a loan, your return is different, and that's what cash-on-cash return measures.

What counts as a good cap rate

There's no single number. In expensive coastal cities, cap rates of 3% to 5% are common because buyers accept low yield for appreciation. In lower-priced Midwest and Southeast markets, 6% to 9% is more typical, and the higher figures usually come with older housing or a rougher area. A higher cap rate means more income per dollar of price, and it can also mean more risk.

Use it to compare two properties, not to judge one in isolation. Our markets pages show an estimated cap rate for the median house in each of ten cities, which is a way to see how it varies.

Where cap rate misleads

• It depends on the expenses you plug in. A seller's listing may leave out management or use last year's tax bill. Recalculate with your own figures.
• It ignores financing. Two buyers with different loans get different returns on the same cap rate.
• It ignores repairs you'll need soon. A roof replacement the NOI doesn't include makes the number look better than it is.

Related reading

The full explanation of a good cap rate covers the market ranges in more depth. To get the number for a specific house, enter its price and rent in the calculator. Cap rate is also a close cousin of the 1% rule, which is a quicker, cruder screen.