Cap Rate Calculator: Plus What the Property Is Worth to You

Introduction

A cap rate deliberately ignores your financing. That is not a limitation to work around — it is the entire purpose, and it is why cap rate answers a different question from every other metric on this site.

TL;DR: Cap rate compares properties. Cash-on-cash compares deals. Because it excludes debt, two investors buying the same building at the same price with wildly different loans see the same cap rate and completely different returns. Use it to decide what a building is worth; use cash-on-cash to decide whether your purchase of it works.

The formula

Cap rate = Net Operating Income
           ÷ Property Value × 100

Where NOI is all income the property collects, minus all operating expenses, and minus nothing for the mortgage:

Gross scheduled = (monthly rent
                  + other income) × 12

Effective gross = gross scheduled
                  − vacancy allowance

Operating exp.  = taxes + insurance
                  + management
                  + maintenance
                  + reserves

NOI             = effective gross
                  − operating exp.

Debt service appears nowhere. Neither does depreciation, income tax, or your personal circumstances.

Worked example

The defaults: a $300,000 property renting for $2,400 a month, 6% vacancy allowance, $3,600 taxes, $1,800 insurance, and 8% management, 7% maintenance and 7% capital reserve.

• Gross scheduled income: $2,400 × 12 = $28,800
• Less 6% vacancy: −$1,728 → effective gross $27,072
• Variable expenses (22% of rent): $6,336
• Fixed expenses: $5,400
• Operating expenses: $11,736
• NOI: $27,072 − $11,736 = $15,336
• Cap rate: 15,336 ÷ 300,000 = 5.11%

The operating expense ratio is 43.4% of effective gross income, which sits in the normal band for residential.

Solving it backwards, which is how it is actually used

Most cap rate calculators stop at the number above. But an investor rarely wants to know a property's cap rate in the abstract — they want to know what to pay.

Rearranged:

Value = NOI ÷ required cap rate

At the same $15,336 of NOI, if you require a 6.5% return the property is worth $235,938 to you. It is listed at $300,000. That $64,000 gap is the negotiation, or the pass.

This is why cap rates matter beyond a single deal. When required returns rise across a market — because rates rose, or risk appetite fell — every property reprices downward on unchanged income:

Required cap rate	Value at $15,336 NOI
5.0%	$306,720
5.5%	$278,836
6.0%	$255,600
6.5%	$235,938
7.0%	$219,086
8.0%	$191,700

Nothing changes at the building between the top row and the bottom, and it loses over a third of its value. Cap rate expansion is the mechanism behind almost every commercial real estate loss cycle.

What cap rate does not tell you

Anything about your financing. Two buyers at $300,000 — one paying cash, one at 25% down and 7.25% — see 5.11% both. Their actual returns are nothing alike. Use the rental ROI calculator for cash-on-cash.

Anything about growth. A 5% cap in a market where rents rise 5% a year beats a 7% cap where they are flat. Cap rate is a snapshot; see the IRR calculator for the multi-year view.

Whether the NOI is real. This is the big one. A seller's pro forma cap rate is computed on the income they claim you could achieve, with expenses that frequently omit management and reserves. Recompute it on your own numbers before comparing anything.

Cap rate, GRM and the 1% rule

Three metrics that overlap, in ascending order of rigour:

The 1% rule — monthly rent as a percentage of price. On the example, 0.80%. Fast enough to do in your head on a listing, and it tells you nothing about expenses. Useful as a first filter, useless as an analysis.

Gross rent multiplier — price divided by annual gross rent. Here 10.42. Still ignores expenses, but it is the standard comparison unit in some markets, and it is fine for comparing two properties whose expense structures genuinely match.

Cap rate — the only one of the three that accounts for what the property costs to run. Which means it is also the only one that can be manipulated by an optimistic expense estimate.

A property can pass the 1% rule and have a poor cap rate, if its taxes and insurance are high. That is common in high-tax states, and it is why the 1% rule travels badly across markets.

What is a good cap rate?

There is no absolute answer, because cap rate is a price for risk. Broad bands for residential:

Cap rate	Typically implies
3 – 4%	Prime coastal metro, appreciation-driven, negative cash flow common
5 – 6%	Stable metro, balanced growth and income
7 – 8%	Secondary market, income-driven, slower appreciation
9% +	Tertiary market or higher-risk asset — verify why it is so high

A high cap rate is compensation, not a bargain. It usually reflects thinner tenant demand, older stock, higher vacancy risk, or a market with no rent growth. The question to ask on a 10% cap is not "how do I buy more of these" but "what does the market know that I don't."

FAQ

Does cap rate include the mortgage?

No, and that is deliberate. NOI is calculated before debt service, which is what makes cap rate a property comparison rather than a deal comparison. Include your financing and you get cash-on-cash return instead.

Should NOI include property management?

Yes, whether or not you self-manage. Excluding it is the most common way a seller's pro forma inflates a cap rate, and it makes properties in different management arrangements incomparable — which is the one thing cap rate exists to do.

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

Cap rate is NOI over purchase price, ignoring debt. Cash-on-cash is annual pre-tax cash flow over the cash you actually invested, after debt service. Cap rate describes the building; cash-on-cash describes your position in it.

Is a higher cap rate better?

For a buyer, a higher cap rate means more income per dollar of price — but it also means the market is demanding more return to hold that asset. Higher cap rates cluster in markets with weaker rent growth and higher vacancy risk. Better income, worse growth, more risk.

How do I find cap rates in my market?

Sold comparables with verifiable income and expense figures, brokers' market reports, and CoStar or similar for commercial. Be careful with listed cap rates: they are usually computed on pro forma income and understated expenses. See market analysis for the data sources worth using.

Why did my cap rate change when interest rates changed?

Your property's cap rate did not — its NOI and price did not move. What changed is the cap rate buyers require, because they can now earn more elsewhere with less risk. That repricing shows up when you sell, which is why the exit cap rate assumption matters more than almost anything else in a long-hold model.

Conclusion

Compute the cap rate on your own expense numbers, not the seller's. Then use the target-cap figure to work out what the building is worth to you, and treat the difference against the asking price as the actual subject of the negotiation.