Cap Rate Formula — 2026 Guide

Last Updated: 2026-02-01

Quick Answer

The Cap Rate formula is **Net Operating Income (NOI) ÷ Property Value**. It represents the unleveraged, pre-tax rate of return on an investment property. In the 2026 market, Cap Rates are the primary benchmark for comparing assets across different risk profiles and financing structures.

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Contents

The Mathematical Core of Property Valuation
Step-by-Step Calculation Guide
Cap Rates & Market Cycles
Real-World Yield Benchmarks
The 'Value-Add' Equity Multiplier
Expert Underwriting Tips
Frequently Asked Questions

The Mathematical Core of Property Valuation

The Capitalization Rate (Cap Rate) is the most fundamental metric in income-producing real estate. It represents the unleveraged yield of a property, allowing investors to compare different assets independent of their mortgage terms. To calculate it accurately, you must first determine the Net Operating Income (NOI), which is the total annual income minus all necessary operating expenses. By dividing this NOI by the current market value or purchase price, you arrive at the Cap Rate. Our calculator automates this by breaking down expenses into professional categories, ensuring you don't miss critical line items that could skew your valuation.

Calculate NOI First What is a Good Cap Rate?

Professional Formula

Cap Rate = (Annual NOI / Current Market Value) × 100

Step-by-Step Calculation Guide

Professional underwriting requires more than just plugging in numbers. Follow this rigorous methodology used by institutional analysts.

1. Audit the NOI

Go beyond the broker's pro-forma. Verify actual T12 (trailing 12 months) income and subtract verified operating expenses. Do not include debt service or depreciation.

2. Benchmark the Value

Use the lower of the purchase price or the current appraised market value. For refinancing, always use the most recent third-party valuation.

3. Calculate & Stress-Test

Apply the formula (NOI/Value). Then, run a 'Sensitivity Analysis' by adjusting vacancy and interest rate assumptions to see how the yield holds up.

Cap Rates & Market Cycles

In 2026, we are observing Cap Rate Expansion in secondary markets due to higher sustained interest rates. When interest rates rise, investors demand a higher yield (Cap Rate) to justify the risk over 'risk-free' government bonds. This 'Spread' is the most important metric for institutional investors today. Conversely, Cap Rate Compression occurs in high-demand 'Trophy' markets where limited supply drives prices up even if NOI remains flat. Understanding whether your market is expanding or compressing is vital for timing your entry or exit.

Real-World Yield Benchmarks

Cap Rates vary significantly by asset class and location. Use these 2026 benchmarks to calibrate your investment expectations.

Asset Class & Location	Annual NOI	Market Value	Cap Rate (Yield)
Class A Multifamily (Austin, TX)	$245,000	$4,900,000	5.00%
Class B Office (Phoenix, AZ)	$162,500	$2,500,000	6.50%
Class C Industrial (Secondary)	$102,000	$1,200,000	8.50%
NNN Retail (National Tenant)	$180,000	$3,000,000	6.00%

The 'Value-Add' Equity Multiplier

The most powerful aspect of the Cap Rate formula is its impact on Forced Appreciation. Because commercial value is a function of income, every $1.00 you save in operating expenses (OpEx) is worth far more in total asset value. For example: In a 5% Cap Rate market, reducing utilities by $5,000 annually creates $100,000 in instant equity ($5,000 / 0.05). This is why professional managers focus relentlessly on NOI optimization rather than just rent increases.

+$1

NOI Saving

+$20

Equity Created

Expert Underwriting Tips

Avoid common pitfalls that can lead to overpaying or miscalculating your potential yield.

**Income Integrity**: Never substitute Gross Rent for NOI. This mistake is the leading cause of failed real estate syndications.

**Valuation Timing**: Cap Rates are snapshots. Always use current market comps rather than historical acquisition costs for portfolio revaluation.

**Operational Transparency**: Ensure property taxes are adjusted for the post-sale assessment, as they often jump significantly after a transaction.

Frequently Asked Questions

What is a 'Good' Cap Rate in the current 2026 market?

A 'good' cap rate is entirely relative to the risk profile of the asset and the current interest rate environment. In 2026, we are seeing Class A multifamily properties in core markets trading between 4.5% and 5.5%. If you are looking at Class C industrial or retail properties in secondary markets, you should expect a higher yield (8%+) to compensate for the increased risk of tenant turnover and deferred maintenance. Always compare your result against local 'comps' to ensure you aren't overpaying for the income stream.

Why does Cap Rate ignore mortgage payments and interest?

Cap Rate is designed to measure the intrinsic value and efficiency of the real estate asset itself, regardless of who owns it or how they chose to fund it. By excluding debt service, the metric allows for an 'apples-to-apples' comparison between two properties. One investor might pay all cash, while another might leverage at 80% LTV; the Cap Rate remains the same for both, as the property's ability to generate income from its physical operations is unchanged by the financing structure.

How do Interest Rates affect property Cap Rates?

There is a strong inverse correlation between interest rates and property valuations (which drives cap rates). When the cost of borrowing increases, investors typically demand a higher Cap Rate (a 'spread' over the risk-free rate) to justify the investment. This often leads to 'cap rate expansion,' where property values must decrease if the NOI remains stagnant. Understanding this relationship is vital for timing your entry or exit in the real estate market.

Is a higher Cap Rate always better for an investor?

Not necessarily. A high cap rate often signals higher perceived risk. For example, a property with a 12% cap rate might be located in a declining neighborhood, have a tenant with poor credit, or require significant structural repairs (CapEx). Conversely, a 4% cap rate property might be a 'trophy' asset in a high-demand city with a 20-year lease from a blue-chip corporation. You must weigh the higher yield against the potential for capital appreciation and income stability.

What is the difference between Cap Rate and Cash-on-Cash Return?

The Cap Rate measures the property's yield, while Cash-on-Cash (CoC) measures the investor's actual cash return on the equity deployed. CoC factors in financing (mortgage payments), making it a better metric for evaluating the impact of leverage. If the Cap Rate is higher than your mortgage interest rate, you are experiencing 'positive leverage,' which will boost your Cash-on-Cash return significantly above the property's base Cap Rate.

Should I include Capital Expenditures (CapEx) in my NOI calculation?

Standard real estate accounting distinguishes between Operating Expenses and Capital Expenditures. NOI generally only includes recurring operating expenses (repairs, taxes, etc.). Major one-time costs like a new roof or HVAC system are considered CapEx and are usually handled 'below the line' in a full cash flow analysis. However, many sophisticated investors use a 'Reserve for Replacements' (e.g., $250/unit/year) as an operating expense to account for these long-term costs in their Cap Rate analysis.