Cap rate (capitalization rate) is the ratio of a property's net operating income (NOI) to its purchase price or current market value. It's calculated as: Cap Rate = (NOI ÷ Property Value) × 100. A cap rate of 6% means the property generates $6 of net income for every $100 of property value.

How do you calculate cap rate?

To calculate cap rate: 1) Determine the property's annual Net Operating Income (NOI) by subtracting operating expenses from gross income. 2) Divide the NOI by the property's purchase price or market value. 3) Multiply by 100 to convert to a percentage. Formula: Cap Rate = (NOI ÷ Property Value) × 100.

Is a higher or lower cap rate better?

Neither is inherently 'better'—it depends on your investment strategy. Higher cap rates (8%+) offer higher returns but come with more risk, older properties, or secondary markets. Lower cap rates (4-6%) indicate stable properties in prime locations with lower perceived risk but also lower returns. Choose based on your risk tolerance and investment goals.

What's the difference between cap rate and cash-on-cash return?

Cap rate measures a property's unlevered return (assuming all-cash purchase) based on NOI divided by property value. Cash-on-cash return measures your actual cash return on the cash you invested, accounting for financing. If you use a mortgage, your cash-on-cash return will typically differ from the cap rate due to leverage effects and debt service.

Cap Rate Calculator

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Property Details

Net Operating Income (NOI)

Annual income after expenses (excluding debt service).

Purchase Price

Total acquisition cost or current market value.

Need to calculate your Net Operating Income first? Use our NOI Builder Tool.

Cap Rate

7.50%

NOI / Purchase Price

Your 7.50% cap rate suggests a moderate-risk profile, typical for Class B properties with solid fundamentals.

4-6%Lower Risk (Class A)

6-8%Moderate Risk (Class B)

8-10%Higher Risk (Class C)

10%+High Risk / Distressed

Next Step: Calculate your actual cash return

Calculate Cash-on-Cash Return →

Next Step Analysis

Verify NOI Inputs → Ensure your income and expense assumptions are accurate. Calculate Cash-on-Cash Return → See your actual return after debt service.

💡 Pro Tip: Compare your cap rate to the 10-year treasury rate. A healthy commercial property should offer at least 2-3% above treasury rates to justify the risk premium.

Understanding Cap Rate

The Capitalization Rate, or "Cap Rate," is one of the most fundamental metrics in commercial real estate analysis. It represents the unlevered annual rate of return an investor can expect to generate from an income-producing property. In simple terms, it measures a property's profitability relative to its purchase price.

Formula

Cap Rate = (Net Operating Income / Purchase Price) × 100

Investors use cap rates to quickly compare the performance of different properties or markets. A higher cap rate generally indicates a higher potential return but often comes with higher risk. Conversely, a lower cap rate implies lower risk and a more stable, predictable income stream, but with a lower return.

Frequently Asked Questions

What is a good cap rate?

It depends on property type, location, and risk tolerance. Generally, 5–10% is a common range for stable commercial properties in urban areas. Lower cap rates (4-6%) imply lower risk and higher value, while higher rates (8%+) suggest higher risk or a value-add opportunity.

Can cap rate predict future returns?

No, a cap rate is a snapshot of a property's performance based on its current net operating income. It does not account for future appreciation, changes in market rents, or unexpected expenses. It's a measure of current yield, not a projection of total return.

How do interest rates affect cap rates?

Rising interest rates typically increase cap rates (which lowers property values). This happens because as borrowing becomes more expensive, investors demand higher returns (a higher cap rate) to compensate for the increased cost of financing and to match yields available from lower-risk investments like bonds.