Measures a property's annual return assuming an all-cash purchase, independent of financing.
What is cap rate in real estate?
Cap rate, short for capitalization rate, is the most widely used metric in real estate investment analysis. It expresses a property's annual net operating income as a percentage of its purchase price — telling you what return the property generates if you paid cash with no mortgage.
The formula is simple: divide the Net Operating Income (NOI) by the property's purchase price or market value, then multiply by 100. A property worth $400,000 generating $28,000 in NOI has a cap rate of 7.0%.
Cap rate is a pre-debt metric — it ignores how you finance the purchase. This makes it the standard apples-to-apples comparison tool between properties and markets. For returns that include your mortgage, see cash-on-cash return.
How to calculate cap rate — step by step
- Calculate Gross Rental Income — multiply the monthly rent by 12. A unit renting at $2,500/month generates $30,000/year.
- Subtract vacancy allowance — multiply by your vacancy rate (typically 5–10%) and subtract it. At 5% vacancy: $30,000 × 0.95 = $28,500 effective gross income from rent.
- Add other income — parking, laundry, storage, pet fees. Add these to get your Effective Gross Income (EGI).
- Subtract all operating expenses — property taxes, insurance, property management, maintenance, utilities paid by owner, HOA, CapEx reserve. Do not include your mortgage payment.
- You now have your NOI — EGI minus total operating expenses. This is the property's cash engine.
- Divide NOI by purchase price × 100 — $28,000 ÷ $400,000 × 100 = 7.0% cap rate.
Monthly rent: $2,500 × 2 units = $5,000/mo → $60,000/yr
Less 5% vacancy: − $3,000 = $57,000 EGI
Property tax: $6,000 | Insurance: $1,500 | Management (10%): $6,000
Maintenance: $2,500 | CapEx reserve (5%): $3,000
Total expenses: $19,000
NOI = $57,000 − $19,000 = $38,000
Purchase price: $600,000
Cap Rate = $38,000 / $600,000 × 100 = 6.33%
What is a good cap rate?
"Good" is relative to your market and property type. A 5% cap rate for a Class A apartment building in New York City is strong — institutional money accepts lower returns in liquid, high-appreciation markets. A 5% cap rate for a strip mall in rural Ohio is weak — the risk doesn't justify the return.
The clearest benchmark: your cap rate should exceed your mortgage rate to generate positive leverage. At a 7% mortgage rate, you need a cap rate above 7% for the debt to work in your favor. Below that threshold, every dollar of leverage reduces your return.
| Context | Typical Cap Rate | Verdict |
|---|---|---|
| Class A multifamily, Tier 1 (NYC, SF) | 3.5–4.5% | Market-rate — strong appreciation play |
| Class B/C multifamily, Tier 2 (Dallas, Atlanta) | 5.0–6.5% | Solid cash-flow deal |
| Single-family rental, Tier 3 | 6.0–8.0% | Strong cash-flow, higher management risk |
| Industrial / warehouse, national | 4.5–6.5% | Strong fundamentals, long leases |
| Below mortgage rate (any market) | Varies | ⚠️ Negative leverage — be cautious |
Cap rate vs. cash-on-cash return — what's the difference?
These two metrics answer different questions. Cap rate tells you what the property earns on its own. Cash-on-cash tells you what your cash earns after the mortgage.
Cap Rate
Measures the property's unlevered return. Ignores how much you borrowed and at what rate. Use it to compare properties side-by-side and negotiate purchase price.
Formula: NOI ÷ Property Value × 100
Cash-on-Cash Return
Measures your actual return on the cash you invested (down payment). Includes your mortgage payment. The metric that tells you what's actually going into your pocket.
Formula: Annual Cash Flow ÷ Down Payment × 100
Property: $400,000 | NOI: $28,000 | Cap Rate: 7.0%
Down payment (25%): $100,000 | Loan: $300,000 | Monthly payment: $2,000 (7% rate, 30yr)
Annual debt service: $24,000
Annual cash flow: $28,000 − $24,000 = $4,000
Cash-on-cash: $4,000 / $100,000 = 4.0%
The property earns 7.0% on its full value, but you earn 4.0% on the cash you put in — because debt service consumes most of the NOI.
How to calculate NOI (Net Operating Income)
NOI is the single most important number in real estate investing. Everything else — cap rate, property value, loan approval — flows from it. Getting it right matters.
NOI = Effective Gross Income − Total Operating Expenses
What is included in operating expenses:
- Property taxes (annual)
- Landlord insurance
- Property management fees (typically 8–12% of collected rent)
- Maintenance and repairs (budget 1% of value/year as a rough rule)
- Utilities paid by the owner (water, trash, gas in common areas)
- HOA and condo fees
- Capital expenditure reserve (typically 5% of gross rent — for roof, HVAC, appliances)
- Accounting and legal fees
Cap rate by city and property type
These benchmark ranges reflect 2025 US market data as reported by institutional investors, commercial brokers, and CBRE/JLL research. They are useful context — always verify current conditions in your specific submarket.
| Property Type | Typical Cap Rate Range |
|---|---|
| Class A Multifamily | 4.0–5.5% |
| Class B/C Multifamily | 5.5–7.5% |
| Single-family rental | 4.5–7.0% |
| Office (prime) | 5.5–7.0% |
| Retail (strip mall) | 6.0–8.5% |
| Industrial / Warehouse | 4.5–6.5% |
| Self-storage | 5.5–7.5% |
| Market Tier | Typical Multifamily Cap Rate |
|---|---|
| Tier 1 (NYC, SF, LA) | 3.5–4.5% |
| Tier 2 (Chicago, Dallas, Miami) | 4.5–5.5% |
| Tier 3 (secondary metros) | 5.5–7.0% |
| Tier 4 (rural / small markets) | 7.0–10%+ |