Cap Rate Explained: Formula, Examples, and What's a Good Cap Rate

If you have looked at more than one listing, you have seen cap rate quoted — sometimes as the headline number on the marketing flyer. Cap rate, short for capitalization rate, is the yield a property produces before any financing enters the picture. It is the fastest way to compare two buildings on equal footing, and the quickest way to spot when an asking price does not match the income.

What cap rate actually measures

Cap rate tells you what return a property generates on its full price, assuming you paid all cash. It answers a single question: for every dollar of value, how much income does this property throw off in a year?

The formula is short:

Cap Rate = Net Operating Income ÷ Property Value

• Net operating income (NOI) is rental income minus operating expenses — taxes, insurance, management, maintenance, vacancy. It does not subtract the mortgage.
• Property value is either the purchase price (for a deal you are analyzing) or current market value (for something you already own).

Multiply the result by 100 to read it as a percentage. A 6 percent cap rate means the property earns 6 cents of NOI per dollar of value, every year, before debt.

A worked example

Take a property on the market for $500,000. After collecting rent and paying every operating expense, it nets the following:

• Net operating income: $30,000
• Property value (asking price): $500,000

Run it:

Cap Rate = $30,000 ÷ $500,000 = 0.06 = 6%

That property has a 6 percent cap rate. If the seller dropped the price to $400,000 with the same $30,000 NOI, the cap rate would rise to 7.5 percent ($30,000 ÷ $400,000) — you would be buying the same income stream for less, so your yield goes up. That inverse relationship is the whole point: price and cap rate move in opposite directions when income holds steady.

Cap rate is the inverse of a price multiple

Here is a mental shortcut that makes cap rate click. A 6 percent cap rate is the same as paying about 16.7 times annual NOI (1 ÷ 0.06). A 10 percent cap rate means paying 10 times NOI. The lower the cap rate, the more years of income you are paying up front — and the more the market is betting on future growth to justify the price.

This is why prime, low-risk assets in supply-constrained cities trade at low cap rates: buyers accept a smaller current yield because they expect rents and values to climb. Higher cap rates show up where that growth story is weaker.

What counts as a "good" cap rate

There is no single correct cap rate, and anyone who quotes one without naming a market is guessing. The number is set by location, asset class, and risk. A rough map:

• 4 to 6 percent — hot, coastal, supply-constrained markets. Lower yield, but stronger appreciation and easier exits.
• 7 to 10 percent and above — secondary and tertiary markets, older buildings, or property types with more turnover. Higher yield to compensate for slower growth and more risk.
• Below 4 percent — trophy assets or markets where buyers are paying almost entirely for future upside.

A "good" cap rate is one that beats comparable sales in the same submarket while matching your risk tolerance. An 8 percent cap rate is excellent in a market where everything trades at 6 — and a warning sign in a market where everything trades at 11, because it usually means the income figure is shakier than it looks.

Higher cap rate, higher risk

It is tempting to chase the highest cap rate on the board. Resist it. A cap rate climbs for two reasons, and only one of them is good news.

The good reason: you negotiated a lower price for solid income. The bad reason: the market is pricing in problems — weak job growth, deferred maintenance, tenant instability, or rents that will not hold. The same 9 percent cap rate can be a steal or a trap depending on which story is true. Always pressure-test the NOI behind the number before you celebrate the yield.

Where cap rate stops being enough

Cap rate is unlevered by design, which is its strength and its limit. It strips out financing so you can compare properties cleanly, but it also tells you nothing about your actual return once a loan is involved. Two investors buying the same 6 percent cap property can earn wildly different returns depending on their down payment and interest rate. That gap is what cap rate versus cash-on-cash return comes down to, and it is why serious underwriting never stops at the cap rate.

To see what you actually pocket after the mortgage, you need cash-on-cash return, which divides your annual cash flow by the cash you put in. Read the two side by side: cap rate tells you whether the asset is priced right; cash-on-cash tells you whether the deal works for you.

Tracking cap rate across a portfolio

For one property, cap rate is a quick division. Across a portfolio, it becomes a live signal. As rents rise or values shift, the implied cap rate on each asset moves — and a rising cap rate on something you already own can flag a value you are leaving on the table, or a building whose income is slipping.

Portfoliq's deal analysis computes cap rate alongside NOI, cash-on-cash, and DSCR the moment you enter a deal, so you can compare a new acquisition against your existing holdings without rebuilding a spreadsheet. You see the same yield a broker would quote, grounded in the expense numbers you actually expect.

The takeaway

Cap rate is NOI divided by property value — the unlevered yield a property earns before any loan. Calculate it on a price and an honest NOI, judge it against comparable sales in the same market rather than a universal target, and remember that a high cap rate usually buys you more risk along with more yield. It is the right tool for comparing similar properties and a poor one for measuring your personal return, so pair it with cash-on-cash before you commit.