If you are considering buying a rental property, one tidbit of advice you may keep hearing is to “check the cap rate.” But calculating the property’s cap rate and knowing what that information means are two different things.
This article has two parts:
- A calculator tool you can use to estimate the cap rate on your new rental property
- An in-depth guide on cap rates, how to assess property cap rates, and what they mean for your overall investment
Ultimately, cap rates are just one factor that goes into the decision to buy an investment property. This article will show you how to evaluate cap rates and help you understand when they should impact your investment decision.
What is a cap rate?
A cap rate is a real estate metric that represents the expected financial return on a rental property. It is typically expressed as a percentage value and is equal to the annual net operating income (NOI) of the property divided by the purchase price/current market value:
Net operating income is equal to the gross income the property generated minus necessary expenses, like taxes and maintenance.[1] Note that these calculations exclude mortgage obligations.
For example, a property purchased for $300,000 with a NOI of $18,000 would have a cap rate of ($18,000 ÷ $300,000) x 100 = 6%. You can think of a cap rate as a snapshot of a property’s potential income relative to its value at a specific point in time.
It tells you how much of the property’s current value you’d earn back annually from rental income.
A higher cap rate means higher potential returns, but also higher risk. Conversely, lower cap rates mean lower returns but a more stable investment.
How to use the calculator
Below is a quick guide on what the fields of the calculator tool mean and how to calculate them. You can also use our rental property calculator and home affordability calculator for more real estate insights.
Property value or purchase price
The most useful way to calculate a cap rate is to use the property’s current market value. Using this price lets you calculate your entry cap rate, which is useful when comparing different potential rental properties.
The current property price lets you determine how much you’d start earning right off the bat if you bought the property.
Gross annual rental income
Gross rental income is the total amount of money your property would generate in rental income at 100% occupancy. Multiply the expected monthly rent by 12 to get the gross rental income. Don’t subtract anything from this number yet.
Example: A property that you rent for $2,000 a month would have a gross rental income of $24,000 before accounting for expenses.
Operating expenses
Operating expenses include everything it costs to run the property on a day-to-day basis. This includes things like property taxes, insurance, maintenance and repairs, and utilities.[2]
It also includes potential property management fees, which usually hover between 6% and 12%.[3] It does not include mortgage payments, income taxes, or property depreciation.
Vacancy rate
The vacancy rate is the expected percentage of the property that will remain vacant during the year. It is equal to the number of empty units divided by the total number of units.
Typically, 5% to 10% is a reasonable estimate for single-family homes, but vacancy rates for multi-family properties can vary significantly. Vacancy rates reduce your expected gross rental income, so it’s important to account for them in calculations.
This calculator doesn't include a field for vacancy rates, but it's something you should keep in mind as you're navigating questions about cap rates.
| Included in Operating Expenses | Not Included in Operating Expenses |
|---|---|
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Cap rate formula: How to calculate it, step by step
The basic formula for cap rates is as follows:
- Cap rate (%) = (NOI ÷ Current Property Value) x 100
To calculate the net operating income, you would first add up your expected annual gross rental income, then subtract values for vacancies and all operating expenses.[4]
Let’s break down this formula using real numbers to see how it works. Imagine a single-family property in a mid-tier rental market with these figures:
- Gross rental income. $24,000 ($2,000/month)
- Vacancy rates. 5% (-$1,200)
- Operating expenses. -$7,200 ($2,400 property taxes, $1,200 insurance, 8% = $1,920 management fees, $1,680 maintenance)
- Net operating income: $15,600
- Purchase price. $250,000
- Expected cap rate: $15,600 ÷ $250,000 = 6.24%
What this number tells you is that you can expect to earn 6.24% of the property purchase price in rental income each year.
One common mistake many owners make is not properly factoring in the vacancy rate, resulting in an incorrect cap rate figure.
For example, excluding vacancy rates from the above calculation would result in a calculated cap rate of 6.7% instead of 6.24%. The difference is small on short timeframes, but it can introduce errors in multi-year calculations.
What’s a good cap rate?
What counts as a "good" cap rate is subjective. Some experts say to target 4–10%, but cap rates can be misleading without context.
What makes a good cap rate depends largely on the type of property, its location, and other market factors.
Below are some useful cap rate benchmarks for various classes of rental properties:[5] [6]
| Property type | Typical cap rate range (2025) | What it signals |
|---|---|---|
| Multifamily Class A | 4.74–5.5% | Premium, low-risk; tight returns, high appreciation potential |
| Multifamily Class B/C | 4.9–6.25% | Mid-tier; balance of income and stability |
| Single-family rental | 4–8% | Highly location-dependent |
| Retail | 5.5–7% | Elevated risk: e-commerce pressure |
| Office | 7%+ (many metros) | High risk: vacancy challenges persist |
| Industrial Class A | 4.84–6.7% | Strong fundamentals in 2025 |
High-demand urban markets (e.g., San Francisco, New York, Seattle, etc.) tend to squeeze cap rates to lower values (3–4%), even on higher quality assets.
Lower-demand markets are reflected with higher cap rates (7%+) due to investors' greater expected returns. So a 5% cap rate may be great in markets like San Francisco but worrisome in a smaller Rust Belt city.
“You can't compare a turnkey, A-class, fully-occupied 5-unit apartment building in a trendy metro neighborhood to a gut-job duplex on the bad side of town,” says Ryder Meehan, CEO and Founder of TaxDrop.
“Checking relevant comps to find the going rate for the cap rate is key, and knowing what you can handle. For example, a higher cap rate typically means more work and risk.”
In today’s market, cap rates have reached a period of stabilization after a period of uncertainty. Total real estate sales transactions increased 19% year-over-year, and more lenders are entering the market as debt has become more available.[6]
Average cap rates hover at just below 7%, indicating that investors are demanding a high return on their investments.
Cap rate vs. cash-on-cash return vs. ROI
One shortcoming of cap rates as a metric is that they ignore how you financed the deal. Cap rate calculations explicitly exclude mortgage payments and mortgage interest. Once you factor in mortgage payments and other financial costs, cap rates stop telling you how much you actually earn on your invested money.
Think of it this way: Cap rates tell you what you’d earn on a property assuming you paid for it in cash. It’s a metric that’s supposed to apply regardless of financing.
Your cash-on-cash return tells you how much actual money you will earn relative to the cash you invested. For example, say you made a $50,000 down payment on your property and have a rental income of $5,000 after subtracting mortgage payments. In this case, your cash-on-cash return would be $5,000 ÷ $50,000 = 10%.
Lastly, your return on investment (ROI) is the total returns you earn from appreciation, equity, and tax benefits. It’s a long-term metric meant to show the stability of an investment. ROI is equal to your annual return over your total investment.
| Cap rate | Cash-on-cash return | ROI |
|---|---|---|
| Income generated compared to property value | Actual cash flow compared to total cash invested | Total profit compared to total investment |
Limitations of cap rate: When to use it and when not to
Cap rates are not the only metric you should look at, and they may be misleading sometimes. Cap rates are most useful as a metric when:
- There are comparable properties in the same market and asset class.
- The property has a stable and documented income history.
- You are doing a first-pass screen for potential properties.
Alternatively, cap rates are less useful and may be misleading when:
- There is a lack of verified income or occupancy history (common with short-term rentals or rehab properties).
- The property’s expected value is in appreciation, not its income-producing potential.
- You rely on the seller’s stated NOI, not the actual 12-month numbers.
- You have a mortgage and other financing costs.
One extremely common mistake many investors make is including their mortgage payments when calculating NOI. NOI is a pre-debt figure, and including debt can distort cap rates and underestimate the property’s income-producing potential.[7]
Cap rate in 2026: What the market looks like right now
Cap rates were heavily compressed during the 2020–2021 low-interest-rate environment, but rates sharply rose after 2022. As property values have since adjusted downward, cap rates have been pushed higher.
According to CBRE’s US Cap Rate Survey H2 2025, all property cap rates rose steadily over the previous six months. Prices stabilizing, and debt becoming more available, contributed to a 19% year-over-year sales volume increase. Cap rates for Class A multifamily units settled around 4.74% in Q1 2025, but single-family units continue to vary significantly depending on the market.[6]
What’s the practical takeaway for investors? Investors in denser, high-demand urban markets should target a cap rate of 5–6% to be in line with market norms.
If you’re calculating cap rates higher than 8%, there may be underlying issues with the property that you should investigate. You can also talk to an investment real estate agent to help you identify properties with reliable cap rate metrics.
FAQ
What does a cap rate tell you?
Cap rate tells you what percentage of a property's value it generates in net income each year, assuming you bought it in cash. A 6% cap rate means the property earns 6% of its purchase price annually in NOI. It's most useful for comparing similar properties in the same market — not as a standalone go/no-go signal.
What is a good cap rate for a rental property?
Generally, 4–10% is considered the normal range, but context matters enormously. In high-demand urban markets, 4–5% can represent an excellent deal. In rural or riskier markets, 8–10% is common but reflects higher risk. In 2025, multifamily assets in major metros typically trade at 4.74%–5.5%. Always compare to local benchmarks, not a national average.
Is a higher cap rate always better?
Not necessarily. A higher cap rate often signals higher risk — more vacancy, a less desirable location, deferred maintenance, or an unstable tenant base. Sophisticated investors don't just chase the highest cap rate; they look for the best risk-adjusted return. A 4.5% cap rate on a stabilized asset in a growing city can outperform a 9% cap rate on a troubled property.
Does cap rate include mortgage payments?
No. Cap rate is calculated using net operating income, which explicitly excludes mortgage principal, interest, depreciation, and income taxes. This makes it useful for comparing properties regardless of how they're financed. But if you're buying with a mortgage, you should also calculate your cash-on-cash return, which accounts for your actual debt service and tells you what you earn on your invested dollars.
How is cap rate different from cash-on-cash return?
Cap rate measures a property's income relative to its total value, ignoring financing. Cash-on-cash return measures your actual cash income relative to the cash you invested, including the effect of your loan. A property with a 5.5% cap rate could deliver a 9%+ cash-on-cash return if financed efficiently — or negative cash flow with an unfavorable loan. Use both metrics together for a complete picture.