Capitalization rate is annual net operating income divided by a property's purchase price or stated valuation, before financing.
Frequently asked questions
What is cap rate in real estate?
Cap rate (capitalization rate) measures a property's unleveraged annual return — what it would yield if you bought it with all cash. The formula is: Cap Rate = Net Operating Income (NOI) ÷ Property Value × 100. A $300,000 property producing $21,000 in NOI has a 7% cap rate. Cap rate is most useful for comparing income properties of similar type in the same market because it strips out financing differences.
What is a good cap rate?
Context drives the answer more than any single number. In primary coastal markets (New York, San Francisco, Boston), 4–5% cap rates are normal because appreciation expectations drive valuations. In secondary and tertiary markets in the Midwest and Southeast, investors typically expect 7–10%. Most experienced investors set a minimum floor of 5% for any income property to ensure there's real yield, not just speculation. Single-family rentals, multifamily, and commercial properties have different norms — compare within asset class and market, not across them.
How is cap rate different from cash-on-cash return?
Cap rate ignores financing — it measures the property's return as if purchased with all cash. Cash-on-cash return (CoC) includes your actual financing: Annual Pre-Tax Cash Flow ÷ Total Cash Invested. A property with a 7% cap rate might only yield 4% CoC if you finance at high rates — or 12% CoC if rates are low and rent income is strong. Use cap rate to value and compare properties; use cash-on-cash to evaluate your actual return on invested capital.
How does cap rate affect property value?
Cap rate and value move in opposite directions when NOI is held constant — when market cap rates rise, property values fall, and vice versa. This inverse relationship is the same as the price/yield relationship in bonds. A property generating $25,000 NOI is worth $357,000 at a 7% cap rate, but only $312,500 at an 8% cap rate. This is why rising interest rates compress real estate values: higher rates push market cap rates up, which mechanically reduces what investors will pay for the same income stream.
What expenses are included in NOI?
NOI includes all operating expenses directly tied to running the property: property taxes, insurance, property management fees (typically 8–10% of gross rent), maintenance and repairs, vacancy loss, utilities paid by owner, and capital expenditure reserves. It does NOT include mortgage principal, interest payments, depreciation, or income taxes — these are below-the-NOI-line items. The most common mistake is including the mortgage payment in operating expenses, which underestimates NOI and inflates the apparent cap rate.