Cap rate divides a property's net operating income by its price or value, giving you a single percentage that lets you compare a duplex in one city against an apartment block in another without worrying about financing. It ignores your mortgage entirely, which is the point: it measures the return the asset itself produces, not the return you personally get after debt and taxes.
What counts as a normal cap rate
Cap rates move with interest rates, location and property type, so there is no single correct number, but ranges are stable enough to be useful. Core apartment buildings in expensive coastal metros have traded in the 4-5.5% band in recent cycles, ordinary suburban multifamily and retail commonly sits around 6-8%, and higher-risk assets such as older properties, secondary markets or short-term leases often need 9% or more to attract a buyer.
A cap rate well below the local norm usually signals a premium location, new construction, or a seller pricing on hoped-for rent growth rather than current income. A cap rate well above the norm usually means deferred maintenance, a weak tenant, a shrinking population, or a NOI figure that has been flattered by leaving out a real cost.
Because the metric compares like against like only when the income figure is calculated the same way, always check what the seller included in NOI before trusting the headline percentage on a listing.
Three worked examples
A 12-unit apartment building priced at 900,000 with net operating income of 49,500 a year returns a cap rate of 5.5% (49,500 divided by 900,000). That sits at the pricier end of the range, consistent with a stable asset in a competitive market.
A single-family rental listed at 320,000 with NOI of 22,400 works out to a 7.0% cap rate (22,400 divided by 320,000), a middle-of-the-road figure for a smaller residential property.
A small retail strip priced at 150,000 with NOI of 13,500 returns a 9.0% cap rate (13,500 divided by 150,000). The higher number could reflect genuine value, or it could be pricing in vacancy risk that a quick look at the rent roll would reveal.
Using cap rate to back into a price
The same formula runs in reverse to sanity-check an asking price: divide NOI by the cap rate you think the market demands. A property generating 24,000 in NOI priced against a 6% market cap rate should sell near 400,000 (24,000 divided by 0.06); if it is listed at 460,000, either the buyer needs a lower cap rate to make sense of it or the price has room to fall.
This reverse calculation is also how appraisers and lenders sanity-check offers on income property, so running it before you make one tells you whether your number will survive underwriting.
Where the formula stops being reliable
Cap rate assumes the NOI you plug in is accurate and repeatable, but many sellers report a pro-forma NOI based on market rents rather than the rent actually being collected, or they omit a vacancy allowance, a reserve for capital repairs, or management fees because the current owner self-manages. Recalculate NOI from the actual trailing twelve months of income and expenses, add a realistic vacancy factor and a management fee even if you plan to self-manage, and the cap rate usually comes down.
The metric also says nothing about financing, so two buyers looking at the same 7% cap rate property can get very different personal returns depending on their loan rate and leverage; cash-on-cash return, not cap rate, tells you what your own money earns.
It breaks down further on properties with unstable income, such as a building mid-renovation, a hotel, or a single-tenant property near lease expiry, because a one-year NOI snapshot does not capture what income will look like once the situation changes.
Market and timing caveats
Cap rates compress when interest rates fall and widen when they rise, because investors demand a spread over the return available on safer assets such as government bonds. A cap rate that looked generous when the 10-year Treasury yield was near 1.5% can look thin once that yield moves several points higher, so compare a cap rate against the interest-rate environment it was set in, not just against a rule of thumb from a few years ago.
In the United States, listing agents typically quote NOI before debt service and before income tax, and before any depreciation deduction, which is standard practice but worth confirming line by line rather than assuming.
Outside the US, conventions vary: UK commercial property is often quoted on a gross or net initial yield basis that can include or exclude purchaser's costs such as stamp duty and legal fees, so a UK yield and a US cap rate are not always calculated on the same basis even when both are expressed as a percentage of price.
Frequently asked questions
- What is a good cap rate for a rental property?
- There is no universal figure, but 6-8% is a common range for stable suburban multifamily and single-family rentals in the US, with prime urban assets often trading at 4-5.5% and higher-risk secondary-market deals needing 9% or more to attract buyers. Compare against similar properties in the same submarket rather than a fixed target.
- How do you calculate cap rate?
- Divide annual net operating income by the property's price or current market value, then multiply by 100 for a percentage. Net operating income is rental income minus operating expenses such as taxes, insurance, maintenance and management, but before mortgage payments and income tax.
- Is a higher or lower cap rate better?
- A higher cap rate means more income relative to price, which usually signals higher risk, a weaker location, or a property needing work. A lower cap rate usually means a safer, higher-quality asset that investors are willing to accept a smaller current return to hold. Neither is automatically better; match the cap rate to the risk you actually want.
- Does cap rate include the mortgage payment?
- No. Cap rate is calculated on net operating income before debt service, so it measures the property's own performance independent of how it is financed. Cash-on-cash return, which does subtract the mortgage payment, is the number that reflects what a leveraged buyer actually earns on their cash.
- Why do two similar properties have different cap rates?
- Differences usually trace back to location quality, tenant strength, lease length, building age and condition, or simply how conservatively each seller calculated NOI. Always rebuild NOI from the actual trailing income and expenses rather than comparing headline cap rates from two different listings at face value.
- How does cap rate relate to property value?
- For a given NOI, value and cap rate move in opposite directions: value equals NOI divided by the cap rate. A property earning 24,000 in NOI is worth about 400,000 at a 6% cap rate but only about 267,000 at a 9% cap rate, which is why rising market cap rates push existing property values down even when income stays flat.
Sources
- Federal Reserve Economic Data (FRED) — 10-Year Treasury Constant Maturity Rate — Benchmark long-term interest rate series used to gauge the risk-free rate cap rates are priced against; updated daily by the Federal Reserve Bank of St. Louis.
- IRS Publication 527, Residential Rental Property — Defines which rental income and operating expense categories the IRS recognizes for reporting purposes, relevant to building an accurate NOI figure; 2024 tax year edition.