Cap Rate Formula – How to Calculate Cap Rate
You found a $2,000,000 property that generates $150,000 in annual Net Operating Income (NOI). Is that a good deal?
Before you open a spreadsheet, you only need one formula:
Cap Rate = NOI / Property Value
This page walks you through the cap rate formula, step-by-step examples, and common pitfalls so you understand why the calculator gives you a certain number – not just the final percentage.
Cap rate formula and key variables
The capitalization rate (cap rate) measures how much annual income a property generates relative to its price. It is the simplest way to express the relationship between income and value for an income-producing property.
Cap Rate = Net Operating Income (NOI) / Property Value
Key variables
- NOI (Net Operating Income) – Annual rental income minus all normal operating expenses (taxes, insurance, maintenance, management, utilities paid by owner, etc.). Debt service is not included.
- Property Value – The current market value or purchase price of the property.
- Cap Rate – The annual return on the property assuming an all-cash purchase, expressed as a percentage.
How to calculate cap rate
When you calculate cap rate by hand, you are really doing two mini-calculations: first getting to NOI, then comparing that NOI to the property’s value.
- Estimate annual rental income. Add up all expected rent and other recurring income over a full year.
- Subtract operating expenses. Include property taxes, insurance, repairs, maintenance, management fees, utilities paid by the owner, and recurring HOA or service contracts.
- Calculate NOI. NOI = Annual Income − Operating Expenses.
- Determine the property’s value. Use the asking price, negotiated purchase price, or your estimate of market value.
- Apply the cap rate formula. Cap Rate = NOI ÷ Property Value. Convert the decimal to a percentage.
Example: If the property generates $40,000 in NOI and is worth $500,000, the cap rate is $40,000 ÷ $500,000 = 0.08, or 8%.
Reverse formulas: from cap rate to NOI or value
Because cap rate is just a ratio between NOI and value, you can easily rearrange the formula to solve for whichever piece you are missing.
Forward cap rate
Use when you know income and price.
Use when you have a return target and price.
Use when you have income and a target return.
In practice, you will rarely do this math by hand more than once. After you understand the relationships, it is much faster to plug your numbers into a calculator and experiment with different scenarios. That is exactly what the full cap rate calculator is built for.
Examples by property type
The formula never changes, but how you interpret the result depends heavily on property type, location, and risk. Here are a few simplified examples.
Example 1 – Apartment building
You are looking at a stabilized apartment building in a major market.
- Purchase price: $2,000,000
- Annual gross income: $220,000
- Operating expenses: $70,000
- NOI = $220,000 − $70,000 = $150,000
- Cap Rate = $150,000 ÷ $2,000,000 = 7.5%
A 7.5% cap rate might be attractive for a stabilized multifamily asset in many secondary markets, but a bit high for prime locations. You would compare this to local benchmarks and your risk appetite.
Example 2 – Single-family rental
Now consider a smaller rental property.
- Purchase price: $200,000
- Annual gross rent: $18,000
- Operating expenses: $6,000
- NOI = $18,000 − $6,000 = $12,000
- Cap Rate = $12,000 ÷ $200,000 = 6.0%
A 6% cap rate might be typical for a stable single-family rental in a stronger market. Cash-on-cash returns will differ once you add financing.
Example 3 – Small commercial property
Finally, a small retail or office property.
- Purchase price: $3,750,000
- Annual NOI: $300,000
- Cap Rate = $300,000 ÷ $3,750,000 = 8.0%
An 8% cap rate can indicate higher risk (tenant concentration, shorter leases, weaker location) but may also point to higher potential returns if you can stabilize or reposition the asset.
For a deeper dive into ranges by asset class and market type, see our guide What is a Good Cap Rate?.
Interpreting your cap rate and common pitfalls
Cap rate is a quick filter, not a full investment model. It tells you how hard the property’s income is working relative to its price, but it does not know anything about financing, future rent growth, or capital expenses.
Common mistakes beginners make
- Mixing cap rate with ROI or cash-on-cash. Cap rate assumes an all-cash purchase. Once you introduce leverage, metrics like cash-on-cash return and IRR become more important.
- Including mortgage payments in NOI. Principal and interest belong below the NOI line. Including them will distort the calculation.
- Ignoring capital expenditures (CapEx). Roof replacements, major renovations, and large one-off items are not annual operating expenses, but they absolutely affect long-term returns.
- Comparing cap rates across very different markets. A 5% cap rate in a core market can be more attractive than an 8% cap rate in a very weak location.
Use cap rate as your first pass filter, then layer in debt, taxes, appreciation assumptions, and exit strategy. Our comparison guides, such as Cap Rate vs ROI, can help you choose the right metric for each decision.
Related tools and guides
Cap Rate Calculator
Plug in your own NOI and property value to calculate cap rate instantly.
What Is Cap Rate?
A beginner-friendly overview of what cap rate means and when to use it.
What Is a Good Cap Rate?
Benchmarks by property type and risk profile to help you judge your deal.
Frequently Asked Questions
What is the formula for cap rate?
The cap rate formula is: Cap Rate = Net Operating Income (NOI) / Property Value. You divide the property's annual NOI by its current market value or purchase price to get a percentage return.
How do you calculate cap rate step by step?
Start by calculating NOI (rental income minus operating expenses), then divide NOI by the property's value and express the result as a percentage. For example, $40,000 NOI ÷ $500,000 value = 0.08, or an 8% cap rate.
What does a 10% cap rate mean?
A 10% cap rate means the property's annual NOI is roughly 10% of its value. In practice, that usually signals higher risk or less desirable properties or locations, but it can also reflect undervalued deals. Always look at NOI quality and market context, not just the number.
Does cap rate include mortgage payments?
No. Cap rate is based on NOI, which excludes debt service such as principal and interest payments. Cap rate assumes an all-cash purchase and focuses on the property's income relative to its price.