The yield a property earns, before the mortgage.
Cap rate is net operating income divided by value. Solve for the cap rate, back into the price a target return justifies, or find the NOI a property needs to hit. See how value and cap rate move in opposite directions.
The numbers
Operating expenses cover tax, insurance, maintenance, management and utilities. Never the mortgage.
What the number tells you
Value at every cap rate
The snapshot
What this NOI is worth at each cap rate
Value = NOI divided by cap rate. As buyers accept a lower cap rate, the same income supports a higher price. Rising cap rates push the value down.
| Cap rate | Implied value | Monthly NOI | Read |
|---|
Cap rate, explained
What Cap Rate Measures
Cap rate (capitalization rate) is annual net operating income divided by property value, expressed as a percentage. It tells you the unleveraged return on the property. A 7% cap rate means the property earns 7% of its purchase price annually before financing.
Reading the Result
Class A urban: 3-5% (low risk, premium market). Class B suburban: 5-8% (typical investment grade). Class C/D rural: 8-12% (higher returns, higher risk). Above 12% usually indicates significant risk or undervalued opportunity.
What NOI Excludes
NOI excludes mortgage payments, depreciation, and income taxes. It includes rent collected minus property taxes, insurance, maintenance, management fees, vacancy allowance, and utilities (if owner pays).
Cap Rate Limitations
Cap rate doesn't account for financing leverage, appreciation, or tax benefits. Use cash-on-cash return for leveraged analysis, IRR for projected appreciation, and after-tax return for full picture.
Common questions
What's a good cap rate?
Depends on market and risk tolerance. 5-8% is typical for stable investment properties. Anything above 10% usually indicates higher risk or rural location.
Should I include mortgage in NOI?
No. NOI is unleveraged. Mortgage payment goes in cash flow analysis, not NOI. This is the standard definition.
Cap rate vs ROI?
Cap rate is unleveraged return on property value. ROI/Cash-on-Cash is leveraged return on cash invested. ROI is usually higher because of mortgage leverage.
Cap rate compression?
When property values rise faster than NOIs, cap rates compress (fall). Signals hot market and lower future returns. Common in major cities 2020-2022.
Cap rate for short-term rentals?
Use net STR income (after platform fees, cleaning, all costs). STR cap rates often look high but include more management work and seasonality.
Estimates for planning only. Cap rate ignores financing, appreciation and tax benefits. Verify NOI, local market cap rates and every expense before you buy or sell.