The capitalization rate (cap rate) is the ratio of a property's Net Operating Income (NOI) to its current market value. It is the primary metric used by real estate investors, appraisers, and lenders to compare the return potential of income-producing properties.
Cap Rate Formula
Cap Rate = (Net Operating Income / Property Value) × 100
Where NOI = Annual Gross Rental Income − Annual Operating Expenses (excluding mortgage payments).
Example: A property generating $30,000 NOI priced at $500,000 has a cap rate of 6.0%. Use the Cap Rate Calculator to compute this instantly.
What Is a Good Cap Rate?
Cap rate benchmarks vary by market and property type. In prime urban markets (New York, San Francisco, London), cap rates of 3–5% are standard — investors accept lower yields in exchange for lower vacancy risk and stronger appreciation prospects. In secondary markets and regional cities, 5–8% is common. Cap rates above 9–10% often signal higher-risk properties requiring more active management.
Cap Rate vs Rental Yield
For residential property, cap rate and net rental yield are often used interchangeably. In commercial real estate, cap rate is the standard term. Both measure NOI divided by property value. The distinction matters mainly when analyzing commercial leases, where "gross" vs "net" lease structures affect how expenses are counted.
Using Cap Rate to Estimate Value
Rearranging the formula: Property Value = NOI / Cap Rate. If comparable properties trade at a 6% cap rate and a building generates $36,000 NOI, its implied value is $600,000. This is how commercial appraisers value income-producing real estate.