Quick answer
The capitalization rate measures a rental property's return independent of financing: annual net operating income divided by price. A property renting for $2,200 a month with $9,132 of yearly operating expenses produces NOI of $15,948; at a $350,000 price, that is a cap rate of 4.56%. At a 7% mortgage rate, financing it loses money in year one.
How the Cap Rate Calculator works, step by step
Enter the annual rent and the operating expenses: property tax, insurance, maintenance, vacancy allowance, management and HOA. The calculator subtracts the vacancy loss from gross rent to get effective gross income, subtracts expenses to get net operating income (NOI), then divides by the purchase price (or current value) to give the cap rate. It also shows the gross rent multiplier — price divided by gross annual rent, 13.26 here.
Two things are deliberately excluded from NOI: the mortgage payment and depreciation. That is the point of the measure — it prices the building, not your loan, so two investors with different financing can compare the same property, and one investor can compare properties across cities. Financing is handled separately, in the cash-flow section below the cap rate.
The financing overlay is where this property's story turns. With 25% down at 7% over 30 years, the loan is $262,500 and annual debt service is $20,957 — more than the $15,948 of NOI. Cash flow is negative $5,009 a year and cash-on-cash return is −5.3% on $94,500 invested. When the mortgage rate (7%) exceeds the cap rate (4.56%), leverage works against you — negative leverage, made visible rather than hidden.
Judge the result against local norms and the risk-free alternative. Cap rates run roughly 4% to 5% in expensive coastal markets and 7% to 10% in cheaper, slower-growing ones. A cap rate far above the local norm is usually compensation for something — deferred maintenance, a weak tenant base, or a declining area — not a bargain. A 4.56% cap rate prices this property for appreciation, not income.
Rebuild NOI from your own expense estimates before trusting any advertised figure. Sellers routinely leave out vacancy, management (even if you self-manage — your time has a value and a buyer will charge it), and realistic maintenance and capital reserves. A listing showing a 7% cap rate on rent minus tax and insurance alone can be a 4.5% cap rate once the missing lines are restored, which is roughly what happens here.
The formula
Cap rate = Net operating income ÷ Property value. NOI = Gross rental income − vacancy loss − operating expenses (excluding mortgage payments and depreciation). Cash-on-cash = (NOI − annual debt service) ÷ (down payment + closing costs).
Worked example — try it on the calculator above
Worked example: $2,200 a month rent, $350,000 price
Gross rent: $26,400 a year. Vacancy at 5%: $1,320, leaving effective gross income of $25,080. Expenses: property tax $4,200, insurance $1,500, maintenance at 5% of rent $1,320, management at 8% $2,112 — total $9,132. NOI = $25,080 − $9,132 = $15,948. Cap rate = $15,948 ÷ $350,000 = 4.56%. Finance it with 25% down at 7% and the mortgage payment is $1,746.42 a month — $20,957 a year, more than the NOI — so the property loses $5,009 a year of cash flow despite a positive cap rate.
Frequently Asked Questions
What is a good cap rate?
There is no universal figure; it prices risk and growth expectations in a specific market. Compare the property's cap rate with recent sales of similar local properties and with the yield on a 10-year Treasury. A rental returning barely more than a government bond, with far more work and risk, is priced for appreciation, not income.
What expenses do sellers leave out of advertised cap rates?
Vacancy, management (even if you self-manage — your time has a value and a buyer will charge it), and realistic maintenance and capital reserves are the usual omissions. A listing showing a 7% cap rate on rent minus tax and insurance alone can be a 4.5% cap rate once the missing lines are restored. Rebuild NOI from your own expense estimates before trusting any advertised figure.
Is a higher cap rate always better?
No. A high cap rate means the price is low relative to current income, which the market usually sets because it expects income to fall, expenses to rise, or the area to decline — or because the building needs work the income statement doesn't show yet. It is a starting question ('why is this cheap?'), not an answer.
How do I use cap rate to estimate a property's value?
Rearrange the formula: value = NOI ÷ market cap rate. If a building produces $15,948 of NOI and comparable properties trade at a 6.5% cap rate, the income-based value is about $245,354 — well below the $350,000 asking price in the example, which tells you the seller is pricing in either lower expenses or expected rent growth.
Estimates, not advice. This calculator provides educational estimates based on the inputs you enter and the assumptions shown on this page. It is not financial, tax or investment advice, and it cannot see your full situation. Verify important figures against official sources, and consider a qualified professional for decisions about your own money. See our Disclaimer and Methodology.