How to Calculate Cap Rate for Commercial Real Estate: Complete 2026 Guide

If you're involved in commercial real estate, the term "cap rate" is one you'll encounter constantly. But what exactly is it, and how do you calculate it? Understanding the capitalization rate is fundamental to evaluating investment properties, comparing opportunities, and making informed decisions. This guide will walk you through everything you need to know about the cap rate formula and how to use it effectively in 2026.

Cap Rate Formula Explained

At its core, the capitalization rate, or cap rate, is a simple formula that measures a property's unlevered rate of return. "Unlevered" means it doesn't account for financing; it evaluates the property as if you bought it with all cash. This allows for a clean, apples-to-apples comparison between different properties.

To use this formula, you need two key pieces of information:

• Net Operating Income (NOI): This is the property's annual income after paying all operating expenses but before paying debt service (mortgage payments) and income taxes. If you're unsure of your NOI, you can calculate it with our free NOI Builder. For a comprehensive breakdown, see our NOI calculator guide.
• Property Value: This is the purchase price or the current market value of the asset.

Step-by-Step Calculation Example

Let's walk through a practical example of how to calculate cap rate. Imagine you're looking at a small apartment building with the following financials:

• Purchase Price: $2,000,000
• Gross Rental Income: $150,000 per year
• Operating Expenses (taxes, insurance, maintenance): $60,000 per year

Step 1: Calculate the Net Operating Income (NOI).

NOI is your gross income minus your operating expenses.

$150,000 (Gross Income) - $60,000 (Operating Expenses) = $90,000 (NOI)

Step 2: Apply the Cap Rate Formula.

Now, divide the NOI by the property's purchase price.

$90,000 (NOI) / $2,000,000 (Purchase Price) = 0.045

Step 3: Convert to a Percentage.

Multiply the result by 100 to express it as a percentage.

0.045 × 100 = 4.5%

In this example, the property's cap rate is 4.5%. This means that for every dollar invested (in an all-cash purchase), you would expect an annual return of 4.5 cents before paying for financing costs.

What is a Good Cap Rate?

A "good" cap rate is subjective and depends heavily on the market, property type, and your risk tolerance. A lower cap rate typically signifies lower risk and a higher, more stable asset value (e.g., a new apartment building in a major city). A higher cap rate suggests higher potential returns but also higher risk (e.g., an older retail center in a small town). For detailed benchmarks by asset class, read our guide on what is a good cap rate by property type.

Common Cap Rate Mistakes

1. Ignoring "Below-the-Line" Expenses

The cap rate formula uses NOI, which excludes debt service and capital expenditures (CapEx). A property might have a great cap rate but poor actual cash flow if the mortgage is too high or it needs a new roof. Always look beyond the cap rate to metrics like Cash-on-Cash Return. Learn more about cap rate vs cash-on-cash return to understand both metrics.

2. Using Pro-Forma Numbers

Sellers often present "pro-forma" financials, which are optimistic projections. Always calculate the cap rate using the property's actual, trailing 12-month (T12) financial data for a more accurate picture of performance.

3. Not Comparing to the Market

A cap rate is only useful in context. A 6% cap rate might be excellent in a prime urban market but poor in a riskier suburban one. Always compare your subject property's cap rate to recent, comparable sales ("comps") in the same submarket.

Understanding how to calculate cap rate is the first step in any sound commercial real estate analysis. It provides a quick and effective way to compare investments and understand the relationship between income and value. By mastering this simple formula, you can make smarter, more confident investment decisions.