How to Calculate Cap Rate: Formula, Examples and Free Calculator (2026)

Cap rate is the first number every rental property investor needs to know. It tells you in seconds whether a property is priced fairly for the income it produces. Once you know how to calculate it, you'll use it on every deal you ever analyze.

The formula is simple: divide net operating income by property value. But the details matter. What counts as an operating expense? What do you leave out? What does your result actually mean?

This guide walks through the full process — the formula, four clear steps, three worked examples with real numbers, and the mistakes that throw off most first-time calculations. We've also linked our free cap rate calculator at each step so you can check your own numbers as you go.

The Cap Rate Formula

Here's the formula:

Cap Rate = (Net Operating Income ÷ Property Value) × 100

That's it. Two inputs, one result expressed as a percentage.

Net Operating Income (NOI) is annual rental income minus annual operating expenses — but never including your mortgage payment. More on that below.

Property Value is the purchase price when you're buying, or current market value when you're assessing something you already own.

A quick example: a property generating $18,000 NOI purchased for $300,000 has a cap rate of ($18,000 ÷ $300,000) × 100 = 6%.

Want to skip the math? Enter your numbers into our free cap rate calculator and get the result instantly.

How to Calculate Cap Rate: 4 Steps

Step 1: Calculate Gross Annual Rental Income

Start with what the property actually earns. Multiply monthly rent by 12.

If a property rents for $1,800 per month, gross annual income is $1,800 × 12 = $21,600.

For multi-unit properties, add all units together first. A duplex with two units at $1,100 each earns $2,200/month, or $26,400/year.

Two important rules here. First, use actual current rents — not what the seller says they could charge, not what Zillow estimates. Second, if the property is vacant, use realistic market rent based on comparable units nearby, not an optimistic number.

Include other regular income if it exists — laundry machines, parking spaces, storage units. Leave out one-time payments like security deposits.

Step 2: Add Up All Operating Expenses

Operating expenses are the regular costs of running the property. Here's what to include:

• Property taxes — get the actual bill, not an estimate
• Insurance — landlord policy, not homeowner's
• Maintenance and repairs — budget 1% of property value per year as a starting point
• Property management fees — typically 8–10% of gross rent, even if you self-manage (your time has value)
• Vacancy allowance — budget 5–8% of gross rent for periods between tenants
• HOA fees — if applicable
• Owner-paid utilities — water, trash, common area electricity if you cover them

Here's what you do not include:

• Mortgage payments — cap rate is financing-independent by design
• Depreciation — a tax benefit, not a cash expense
• Capital expenditures — a new roof or HVAC is not an operating expense
• Income taxes

The mortgage exclusion trips up almost every new investor. Cap rate is meant to measure the property's income yield independent of how you financed it. That's what makes it useful for comparing properties — a cash buyer and a leveraged buyer evaluating the same property will calculate the same cap rate.

Step 3: Calculate Net Operating Income (NOI)

Subtract total operating expenses from gross annual income.

NOI = Gross Annual Income − Total Operating Expenses

Example: $21,600 annual income − $11,400 expenses = $10,200 NOI.

This is the number that matters. It tells you how much the property earns from operations before any financing costs enter the picture.

Step 4: Divide by Property Value and Multiply by 100

Take your NOI and divide it by the purchase price. Multiply by 100 to express it as a percentage.

Continuing the example: ($10,200 ÷ $240,000) × 100 = 4.25% cap rate.

That's your answer. Now you need to know what it means — which we cover in the next section.

Three Worked Examples

Example 1: Affordable Market Single-Family

Property: $165,000 single-family home, $1,500/month rent

• Gross annual income: $1,500 × 12 = $18,000
• Property taxes: $2,400/year
• Insurance: $900/year
• Maintenance (1% of value): $1,650/year
• Management (9%): $1,620/year
• Vacancy (7%): $1,260/year
• Total expenses: $7,830
• NOI: $18,000 − $7,830 = $10,170
• Cap rate: ($10,170 ÷ $165,000) × 100 = 6.16%

A 6.16% cap rate is solid for an affordable market. This property covers expenses well and leaves meaningful income. It's a reasonable buy for a cash flow investor.

Example 2: Mid-Size City Duplex

Property: $320,000 duplex, two units at $1,350 each = $2,700/month total

• Gross annual income: $2,700 × 12 = $32,400
• Property taxes: $4,200/year
• Insurance: $1,400/year
• Maintenance (1% of value): $3,200/year
• Management (9%): $2,916/year
• Vacancy (7%): $2,268/year
• Total expenses: $13,984
• NOI: $32,400 − $13,984 = $18,416
• Cap rate: ($18,416 ÷ $320,000) × 100 = 5.76%

A 5.76% cap rate in a growing mid-size market is competitive. Two-unit properties spread vacancy risk — if one unit is empty you still have income. This is a reasonable deal worth deeper analysis.

Example 3: High-Cost Coastal Market

Property: $875,000 single-family home, $3,200/month rent

• Gross annual income: $3,200 × 12 = $38,400
• Property taxes: $10,500/year
• Insurance: $2,200/year
• Maintenance (1% of value): $8,750/year
• Management (9%): $3,456/year
• Vacancy (5%): $1,920/year
• Total expenses: $26,826
• NOI: $38,400 − $26,826 = $11,574
• Cap rate: ($11,574 ÷ $875,000) × 100 = 1.32%

A 1.32% cap rate looks terrible in isolation. But in an expensive coastal market where prices are driven by appreciation, this is not unusual. Investors here are buying for long-term value growth, not current income. The cap rate alone doesn't tell you whether this is a good or bad investment — that depends on market context.

What Does Your Cap Rate Mean?

Cap rate only has meaning relative to your local market. There is no universal number that is "good." A 5% cap rate can be excellent or poor depending entirely on where the property is.

Here are general benchmarks by market type:

• High-cost cities (San Francisco, New York, Boston): 3–5% is typical. Investors accept low yields for strong appreciation and stability.
• Growing mid-size markets (Austin, Charlotte, Nashville): 5–7% is normal. Solid balance of income and growth.
• Affordable Midwest and Southeast markets (Cleveland, Memphis, Indianapolis): 7–10% is common. Strong cash flow, lower appreciation potential.
• Distressed or high-risk areas: 10%+ often signals problems — deferred maintenance, high vacancy, declining neighborhoods. High cap rate can mean high risk.

The most useful thing you can do is compare your calculated cap rate to recently sold comparable properties in the same area. If similar properties are trading at 7% and the one you're looking at is priced at 5%, the seller is asking for a premium their income doesn't justify.

Run the numbers on your property with our cap rate calculator, then compare your result to what local agents and investors tell you is normal for that market.

Using Cap Rate to Check a Seller's Asking Price

One of the most practical uses of cap rate is working the formula backwards to see if a price is fair.

Maximum Price = NOI ÷ Target Cap Rate

If a property generates $22,000 NOI and comparable properties in that market sell at 7% cap rates, the property's fair value is $22,000 ÷ 0.07 = $314,285.

If the seller is asking $380,000, they're pricing it at a 5.8% cap rate — well below market. You're either overpaying or the seller believes the property will produce more income soon. Both scenarios need to be tested before you make an offer.

This reverse calculation is how commercial real estate professionals price properties. It's just as useful for single-family rentals and small multi-units.

Cap Rate vs Cash-on-Cash Return: Know the Difference

These two metrics confuse new investors constantly. They're related but measure different things.

Cap rate uses total property value and ignores financing. It tells you about the property. It's the same for every investor regardless of how they finance it.

Cash-on-cash return uses only the cash you personally invested — your down payment and closing costs — and includes your mortgage payment. It tells you about your deal. Two investors buying the same property at the same price but with different loan terms will calculate different cash-on-cash returns.

Use cap rate first to screen whether a property is fairly priced. Then calculate cash-on-cash return to confirm your specific financing produces an acceptable return. Our cash flow calculator handles the cash-on-cash math once you have your NOI.

For a deeper comparison of both metrics, read our guide on cap rate vs cash-on-cash return.

Common Calculation Mistakes

Including the mortgage payment. This is the most common error. The moment you include your mortgage, you're no longer calculating cap rate — you're calculating something closer to cash-on-cash return. Keep them separate.

Using projected rents instead of actual rents. Sellers often show you what the property "could" rent for. Base your calculation on what it currently rents for. If the units are vacant, use what comparable units in the same building or street are actually achieving.

Skipping vacancy allowance. Even a fully occupied property will have turnover. Budget 5–8% of gross rent for vacancy. Leaving it out makes every property look better than it is.

Underestimating maintenance. New investors consistently underestimate repair costs. Use 1% of property value as a minimum annual budget. An older property may need more.

Accepting the seller's expense figures without verification. Sellers have an incentive to show low expenses to justify a high price. Always get actual tax bills, insurance policies, and maintenance receipts. If you can't verify the numbers, build in a buffer.

Comparing cap rates across different markets. A 6% cap rate in Memphis and a 6% cap rate in Seattle are not equivalent investments. Always benchmark against local comparables, not national averages.

Frequently Asked Questions

What is the formula for cap rate?

Cap Rate = (Net Operating Income ÷ Property Value) × 100. Net Operating Income is annual rental income minus all operating expenses, not including mortgage payments.

Do you include the mortgage in a cap rate calculation?

No. Mortgage payments are never included. Cap rate measures a property's income relative to its value, independent of financing. This is what makes it useful for comparing properties — the result is the same whether you pay cash or finance 80%.

What is a good cap rate for a rental property?

It depends on the market. In high-cost cities, 3–5% is normal. In mid-size cities, 5–7% is solid. In affordable Midwest markets, 7–10% is common. Always compare against other properties in the same area rather than a national benchmark.

What expenses do you include in a cap rate calculation?

Include property taxes, insurance, maintenance, management fees, vacancy allowance, HOA fees, and owner-paid utilities. Do not include mortgage payments, depreciation, capital expenditures, or income taxes.

Can I use cap rate to figure out what a property is worth?

Yes. Reverse the formula: Property Value = NOI ÷ Cap Rate. If a property generates $30,000 NOI and local cap rates are 6%, the estimated value is $30,000 ÷ 0.06 = $500,000. This is how commercial real estate is priced and helps you check whether a seller's asking price is reasonable.

Is cap rate the same as ROI?

No. Cap rate measures annual operating income relative to property value and ignores financing, appreciation, and taxes. ROI is broader — it includes cash flow, appreciation, mortgage paydown, and tax benefits over your holding period. Use our ROI calculator to model total return alongside cap rate.

How is cap rate different from cash-on-cash return?

Cap rate ignores financing and uses total property value. Cash-on-cash return includes your mortgage and measures return on actual cash invested. Two investors buying the same property calculate the same cap rate but potentially very different cash-on-cash returns based on their loan terms. Read our full cap rate vs cash-on-cash return guide for a detailed comparison.

Should I use purchase price or market value?

Use purchase price when evaluating a property before buying. Use current market value when assessing a property you already own, or when deciding whether to sell.

Start Calculating

Cap rate is the fastest way to screen a rental property. Once you can calculate it quickly and accurately, you'll cut through overpriced listings immediately and focus your time on deals worth analyzing further.

The formula is simple: NOI divided by property value, multiplied by 100. The discipline is in the inputs — using actual rents, conservative expense estimates, and never including the mortgage.

Run any property through the four steps above, then check your result against local market cap rates. If it holds up, move to the next level of analysis. If it doesn't, move on and find a better deal.

Use our free cap rate calculator to run the numbers on any property in seconds. Pair it with our cash flow calculator to add your financing terms and see the complete picture.