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Investing

Capitalization Rate (Cap Rate)

Also called cap rate, capitalization rate

In short

Capitalization rate (cap rate) is a rental property's net operating income divided by its value or price. It shows the property's unleveraged annual return and is used to compare income properties.

Formula
NOI ÷ property value
Ignores
Financing
Higher cap rate
More income, often more risk
Varies by
Market and property type

How to calculate cap rate

Cap rate = net operating income ÷ purchase price (or current value) × 100.

NOI is yearly rent and other income minus operating expenses, before mortgage payments. Because cap rate leaves out financing, it lets you compare properties regardless of how they're bought.

Reading cap rates

A higher cap rate means more income per dollar of price, but often comes with more risk: older buildings, weaker areas or less stable tenants. Lower cap rates are typical in high-demand markets where buyers expect appreciation. Compare a property's cap rate with similar properties nearby, not with a single national number.

Limits of cap rate

Cap rate is a snapshot of one year. It doesn't show the effect of leverage, future rent growth, major repairs or appreciation. Use it alongside cash-on-cash return and a full cash flow analysis.

The formula

Cap rate = Net operating incomeProperty value × 100
Net operating income
Annual rent after vacancy, minus operating expenses (not the mortgage)
Property value
The purchase price or current market value
Try it in the Cap Rate Calculator →
Example

Cap rate on a duplex

A duplex rents for $1,500 per side, or $36,000 a year. After vacancy, taxes, insurance, maintenance and management, operating expenses total $14,400. NOI = $36,000 - $14,400 = $21,600. At a $300,000 price, cap rate = $21,600 ÷ $300,000 = 7.2%.

Capitalization Rate (Cap Rate) vs. Cash-on-Cash Return

Capitalization Rate (Cap Rate)

Capitalization rate (cap rate) is a rental property's net operating income divided by its value or price. It shows the property's unleveraged annual return and is used to compare income properties.

Cash-on-Cash Return

Cash-on-cash return is a property's annual pre-tax cash flow divided by the total cash the investor put in. It measures the yield on your own money after financing.

The differenceCap rate ignores financing and measures NOI against the property's price; cash-on-cash return measures cash flow after debt payments against the cash you actually invested.

Frequently Asked Questions

Related terms

Net Operating Income (NOI)InvestingNet operating income (NOI) is a rental property's yearly income minus its operating expenses, before mortgage payments, depreciation and income taxes. It is the basis for cap rate.BRRRR MethodInvestingThe BRRRR method is a rental investing strategy: buy a distressed property, rehab it, rent it, refinance based on the higher value, and repeat with the cash pulled out.After Repair Value (ARV)InvestingAfter repair value (ARV) is the estimated market value of a property once planned repairs and renovations are complete. Investors use it to decide how much to pay for a fixer-upper.Comparative Market Analysis (CMA)Buying & closingA comparative market analysis (CMA) is a real estate agent's estimate of a home's value based on recent sales, pending sales and active listings of similar nearby properties.AppraisalBuying & closingAn appraisal is a licensed appraiser's independent estimate of a property's market value. Lenders require one to make sure the home is worth at least the amount being borrowed.Hard Money LoanMortgages & financingA hard money loan is a short-term loan from a private lender, secured mainly by the property's value rather than the borrower's income. Investors use it to buy and renovate properties quickly.RefinanceMortgages & financingTo refinance is to replace an existing mortgage with a new one, usually to get a lower rate, change the loan term, or take cash out of the home's equity.The 70% RuleInvestingThe 70% rule is a fix-and-flip guideline: pay no more than 70% of a property's after repair value (ARV) minus the cost of repairs. It leaves room for profit, holding and selling costs.

Learn more in the knowledge base

How to Finance a Foreclosure or Distressed PropertyGuide · 7 min readDistressed properties are harder to finance than move-in-ready homes. Condition, timing and the seller's terms all limit which loans will work. This guide matches financing options to each kind of distressed purchase and explains the trade-offs.How to Evaluate a Pre-Foreclosure DealGuide · 6 min readOnce an owner is interested in selling, you can replace rough screening estimates with real numbers. This guide walks through confirming what is owed, finding every lien, assessing condition and repairs, estimating value, and turning those figures into a maximum price you will not go above.Researching a Foreclosure Property Before the AuctionGuide · 6 min readAt a foreclosure auction you usually buy as-is, unseen and without contingencies, so research done before the sale is your only protection. This guide covers how to confirm the sale details, check title and liens, estimate value and repairs from the outside and turn it all into a maximum bid.
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Disclaimer: The information on this page is for general educational purposes only and is not legal, financial, tax or investment advice. Laws, lending rules and market conditions vary by state and change over time, and any figures shown are estimates. Before you buy, sell, finance or bid on a property, consult a qualified attorney, financial advisor, lender or licensed real estate professional about your situation.