Cap rate is the single number investors compare first when evaluating rental properties. It answers one question: what return am I getting on my cash?
How it works
Cap rate divides a property’s net operating income (the rent minus the costs of running it) by its purchase price. A 5% cap rate on a $500,000 property means it generates $25,000 in annual profit. The higher the rate, the stronger the immediate return.
Why cap rate is not the whole picture
Cap rate ignores what you borrowed to buy the property. If you put 20% down and financed the rest, your actual cash-on-cash return is much higher than the cap rate, because the rental income supports debt service and leaves you with a profit on a smaller investment. Cap rate also ignores appreciation and tax depreciation, which can add significantly to your real return. It’s a quick first filter, not a complete answer.
What this does not include
This calculator assumes you know your net operating income—rental income minus all direct operating costs like taxes, insurance, and maintenance. It does not account for mortgage payments, capital expenditure reserves, or property appreciation.
How to use this calculator
- Enter your property’s net operating income — rental revenue less operating expenses, before you pay any debt service.
- Enter the property value or purchase price.
- The result is your cap rate as a percentage, useful for comparing against other properties or market benchmarks.
Frequently asked questions
Is a 5% cap rate good?
It depends on your market and your other options. In high-cost urban markets, 4–5% is normal. In secondary markets with less demand, you might expect 6–8% or higher. The opportunity cost matters: if you could invest $500,000 in index funds at 10% annual return, a 5% cap rate is not enough to justify the real estate risk and illiquidity.
Why do cap rates vary so much?
Supply and demand. A property in a hot market where investors compete fiercely might sell at a 4% cap rate because everyone wants it. The same property’s income, run in a cold market, might sell at 6% or 7% because fewer buyers are competing. Neither is wrong; they reflect what the market is willing to pay given the risks they see.
Should I compare cap rates across different properties?
Yes, for a quick first pass. But dig deeper: a high cap rate might signal higher risk (higher turnover, worse condition, riskier neighbourhood). Compare cap rates only for properties in similar condition and location, then look at cash flow, appreciation potential, and how mortgage leverage changes your actual return.
How do I calculate net operating income?
Start with gross rental revenue. Subtract property taxes, insurance, maintenance, vacancy allowance (typically 5–10%), property management if you use it, and utilities you pay. Do not subtract mortgage payments or capital gains taxes. What’s left is NOI.
