How to Calculate Cap Rate on a Rental Property (Formula + Examples)

Cap rate is the single most-used metric for evaluating rental properties. It strips out financing and tells you the raw return on a property, which makes it useful for comparing deals across markets, negotiating price, and benchmarking against local comps. Whether you are evaluating a $150,000 duplex in Cleveland or a $2 million apartment building in Phoenix, the formula is the same. Here is how to calculate cap rate, how to interpret the result, and what a good cap rate looks like in 2026.

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The Cap Rate Formula

Cap rate (capitalization rate) is calculated by dividing a property's net operating income (NOI) by its current market value, then multiplying by 100. Cap Rate = (NOI / Property Value) x 100. NOI is annual rental income minus operating expenses, excluding mortgage payments.

Cap rate has two inputs: net operating income and property value. Both require precision.

Net Operating Income (NOI) is the property's annual gross rental income minus all operating expenses. Operating expenses include:

• Property taxes
• Insurance
• Property management fees (typically 8-12% of gross rent)
• Maintenance and repairs
• Vacancy allowance (typically 5-10% of gross rent)
• Utilities paid by the landlord

What is excluded from NOI. Mortgage payments are not operating expenses and are not included in the cap rate calculation. This is intentional. Cap rate is designed to measure property performance independent of how you financed it. Two investors can buy the same property with different down payments and different loan terms, but the cap rate of the property is identical for both. That is what makes it useful for comparing deals on neutral ground.

Capital expenditures (CapEx) such as roof replacements, HVAC systems, and major renovations are typically excluded from the annual NOI calculation, though some analysts include an annual CapEx reserve. If you include a CapEx reserve, apply it consistently across every deal you analyze so your comparisons remain valid.

Property value is either the purchase price (when evaluating a prospective deal) or the current market value (when assessing a property you already own or working backward from a target return).

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Step-by-Step Cap Rate Calculation

The formula applies the same way across property types and price points. Here is the full process with two worked examples.

Step 1: Calculate annual gross rental income

Multiply monthly rent by 12. For multi-unit properties, add all units together before multiplying.

Example: A duplex with each unit renting at $1,000 per month. $2,000/month x 12 = $24,000 annual gross rent.

Step 2: Subtract operating expenses

Expense	Annual Amount
Property taxes	$2,400
Insurance	$1,200
Property management (10%)	$2,400
Maintenance and repairs	$1,500
Vacancy allowance (5%)	$1,200
Landscaping	$300
Total operating expenses	$9,000

Step 3: Calculate NOI

$24,000 - $9,000 = $15,000 NOI

Step 4: Divide NOI by property value

$15,000 / $200,000 = 0.075

Step 5: Multiply by 100

0.075 x 100 = 7.5% cap rate

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Worked Example 2: Larger property, same economics

A fourplex generating $4,000 per month in gross rent comes to $48,000 annually. Operating expenses at roughly the same ratio as the duplex: $18,000 per year. NOI = $30,000. Purchase price: $400,000.

$30,000 / $400,000 x 100 = 7.5% cap rate

Same result, different scale. This illustrates exactly why cap rate is useful for comparing deals of different sizes. The 7.5% figure reflects the property's underlying yield regardless of whether it is a $200,000 duplex or a $400,000 fourplex. Strip out the dollar amounts and the economics are identical.

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What Is a Good Cap Rate in 2026?

There is no universal answer. The right benchmark depends on your market, your strategy, and your risk tolerance.

Market Type	Typical Cap Rate	Investor Profile
Class A (New York, San Francisco, Los Angeles)	3-5%	Appreciation-focused; lower yield, lower volatility
Primary markets (Atlanta, Denver, Dallas)	5-7%	Balanced play; yield plus appreciation potential
Secondary markets (Cleveland, Indianapolis, Memphis)	7-10%	Cash flow-focused; higher yield, more management intensity
Rural or tertiary markets	10%+	Maximum yield; highest vacancy and liquidity risk

The most useful benchmark is local, not national. A 7% cap rate in Indianapolis signals a solid deal. A 7% cap rate in Los Angeles is extraordinary. The CBRE Cap Rate Survey, published annually, provides market-by-market benchmarks across asset classes and is the standard reference for institutional investors. For individual deals, pull cap rates from recent comparable sales in your specific submarket using your local MLS or CoStar data.

Cap rate and risk move together. A higher cap rate is not automatically better. Higher yields in a given market typically reflect higher risk: rougher neighborhoods, older building stock, weaker job markets, or lower appreciation potential. Lower cap rates in Class A markets reflect lower vacancy risk and stronger long-term appreciation. Match the cap rate target to your investment strategy, not to some abstract idea that higher is always preferable.

The nationwide median for single-family rentals sits at approximately 5-7% in 2026, based on NAREIT data. Multifamily assets in primary markets compress toward the lower end of that range. Smaller cities with growing employment bases tend to run 7-9%.

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Cap Rate vs. Cash-on-Cash Return

These two metrics are frequently confused and are not interchangeable. Each answers a different question.

Cap rate is financing-independent. It measures the property's performance at the asset level, regardless of how much you borrowed or at what interest rate. Use it to compare deals and markets, because it eliminates the financing variable.

Cash-on-cash return is financing-dependent. It measures the return on your actual cash invested (down payment plus closing costs) after accounting for debt service. Use it to evaluate your specific return given your loan terms.

The same deal produces two very different numbers:

	Cap Rate	Cash-on-Cash
Property value	$200,000	$200,000
NOI	$15,000	$15,000
Annual mortgage payment	Not included	$10,200
Annual cash flow	$15,000	$4,800
Denominator	$200,000 (value)	$50,000 (down payment)
Return	7.5%	9.6%

Both numbers are accurate. Cap rate tells you what the property produces on its own. Cash-on-cash tells you what your invested dollars earn given your specific financing. You need both to evaluate a deal completely.

ProPilot's deal calculator shows cap rate and cash-on-cash return side by side in a single view, so you can evaluate the property on its own merits and your personal return simultaneously. Investors financing acquisitions with a DSCR loan, which qualifies based on the property's rental income rather than W-2 documentation, can model both metrics against multiple loan scenarios before committing to a purchase.

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To calculate cash-on-cash return alongside cap rate for any deal, use a rental property calculator that handles both metrics in one place.

For a full picture of how lenders evaluate deals differently than cap rate suggests, see our guide to investment property loans.

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Common Cap Rate Calculation Mistakes

Using asking price instead of the negotiated purchase price. A seller can list at any number. Cap rate reflects actual deal economics only when you use the price you actually pay. Calculate cap rate on the asking price to screen deals quickly, then recalculate at your offer price before committing to anything.

Forgetting the vacancy allowance. Projecting gross rent at 100% occupancy overstates NOI. Every property has vacancy between tenants, even in strong markets. A standard vacancy allowance is 5-10% of gross rent depending on market and property type. Skipping it is one of the most common ways investors overestimate pre-close returns.

Including mortgage payments in operating expenses. Cap rate is pre-financing by design. Adding your mortgage payment to expenses produces a distorted number that is neither cap rate nor cash-on-cash return. Keep the calculations separate. NOI excludes debt service; cash-on-cash includes it.

Using gross rent instead of effective gross income. If you pay utilities as the landlord, gross rent overstates the income that reaches your account. Use only the net income after utility costs. The difference matters most for properties where the landlord covers electric, heat, or water.

Applying the wrong property value. If you paid $200,000 five years ago and the property is now worth $350,000, your cap rate based on current market value is meaningfully lower than the cap rate based on original cost. Both calculations are valid; they answer different questions. Using current market value tells you whether holding still makes sense relative to alternatives. Using original cost tells you how the property performed relative to what you paid. Be explicit about which figure you are using and why.

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Frequently Asked Questions

What does a 7% cap rate mean?

A 7% cap rate means the property generates 7% of its value in net operating income annually, before accounting for any financing. On a $300,000 property, that is $21,000 in NOI per year. It does not factor in your mortgage payment. Whether 7% is a good result depends entirely on what comparable properties in that specific market are trading at.

Is a higher cap rate always better?

Not necessarily. Higher cap rates often reflect higher risk: rougher neighborhoods, older properties, lower-growth markets, or weaker tenant demand. A 9% cap rate in a declining market may perform worse over a 10-year hold than a 5% cap rate in a growing one. Match the cap rate to your strategy rather than optimizing for the highest number regardless of context.

Can you calculate cap rate without the purchase price?

Yes. You can use the property's current market value instead of the purchase price. This is useful when evaluating a property you already own or when you want to determine what price to offer given a target return. The formula inverts to: Property Value = NOI / Target Cap Rate. If you target an 8% cap rate and the property has $24,000 in NOI, the maximum price that hits your target is $300,000.

How is cap rate different from ROI?

ROI (return on investment) typically measures total profit divided by total investment over a defined period, and can include appreciation, principal paydown, and tax benefits, not just operating income. Cap rate is narrower: it measures current net operating income relative to value, and it ignores financing entirely. Cap rate is better for comparing properties at the time of purchase. ROI is better for evaluating a complete investment hold over time.

What is a good cap rate for multifamily?

It depends on the market and asset class. In primary markets, multifamily cap rates typically run 4-6%. In secondary markets with strong rent growth, 6-8% is more common. Class B and C multifamily in tertiary markets can reach 8-10% or higher. The CBRE Cap Rate Survey breaks this down by market and asset class annually and is the most reliable benchmark for a specific deal.

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The Bottom Line

Cap rate is a tool, not a verdict. A 7.5% cap rate is neither good nor bad until you compare it against local market data, your investment strategy, and your cost of capital. When calculated correctly, with a complete NOI and an accurate property value, it strips out the noise and tells you what the asset actually produces on its own.

The investors who evaluate deals most accurately use cap rate to screen and compare, then layer in cash-on-cash return to evaluate their personal return given actual financing terms. Running both metrics before making an offer is standard practice. Running them after accepting one is too late.

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