Cap Rate for Rental Property: What It Is, How to Calculate It, and What's Good
Last updated June 2026 · 6 min read
Quick Definition
Cap Rate = Annual NOI ÷ Property Value × 100
A 6% cap rate on a $300,000 property means the property generates $18,000 in net income per year before debt service.
Cap rate — short for capitalization rate — is the single most common metric used to evaluate a rental property's income potential. It tells you what a property earns relative to its price, assuming you paid all cash (no mortgage). Two investors looking at the same deal will always have the same cap rate, regardless of how they finance it.
What Does Cap Rate Actually Measure?
Cap rate measures the yield you'd earn if you owned a property free and clear. It's calculated from net operating income (NOI) — the rent you collect after subtracting all operating expenses, but before your mortgage payment.
Operating expenses that reduce NOI include:
- Property taxes
- Homeowner's insurance
- Maintenance and repairs
- Vacancy (months without rent)
- Property management fees (if applicable)
- HOA fees (if applicable)
Mortgage payments are deliberately excluded. This is what makes cap rate useful for comparing properties across different financing scenarios — or comparing an all-cash deal to a leveraged one.
How to Calculate Cap Rate: Step-by-Step Example
Example: 3-bedroom SFH in Phoenix, AZ
Cap Rate = $18,720 ÷ $380,000 × 100 =
4.9%
What Is a Good Cap Rate?
There's no universal answer — it depends on the market and your investment goals. Here's a rough framework:
| Market Type | Typical Cap Rate | Examples |
|---|---|---|
| High-demand coastal | 3–5% | NYC, LA, SF, Seattle, Miami |
| Suburban / Sun Belt | 5–8% | Phoenix, Atlanta, Dallas, Nashville |
| Midwest / rural | 8–12%+ | Cleveland, Detroit, Memphis, Tulsa |
A high cap rate isn't automatically better. Markets with 10%+ cap rates often have lower appreciation potential, higher tenant turnover, or weaker economic fundamentals. Investors who bought in coastal markets at 3–4% cap rates in 2012 often made more money from appreciation than cash flow investors in high-cap-rate markets.
Cap Rate vs. Cash-on-Cash Return
Cap rate and cash-on-cash return (CoC) are complementary metrics — not interchangeable.
Cap Rate
- • Ignores mortgage financing
- • Same for all investors buying same property
- • Good for comparing properties across markets
- • Doesn't tell you your actual monthly cash flow
Cash-on-Cash Return
- • Accounts for your specific loan terms
- • Changes based on down payment, rate
- • Reflects actual cash yield on your investment
- • Better for deciding between financing options
Use cap rate to screen and compare deals. Use cash-on-cash return to evaluate whether a specific deal works for your financing situation.
Calculate cap rate for any property
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Analyze a property freeCap Rate Limitations to Know
Cap rate is a useful screening tool but has real limitations:
- 1
No financing costs. A 7% cap rate deal with a 7.5% mortgage rate produces negative cash flow. Cap rate alone won't reveal that.
- 2
Expense assumptions vary. Two investors might use different maintenance or vacancy assumptions, producing very different cap rates on the same property.
- 3
Ignores appreciation. A 4% cap rate in Austin might be a better long-term investment than an 8% cap rate in a declining Midwest city, once you factor in rent and value growth.
- 4
Point-in-time snapshot. Cap rate is calculated on current rent. If the property is under-rented or needs work, the cap rate will look worse than what you'll actually earn.
Frequently Asked Questions
What is cap rate in real estate?
Cap rate (capitalization rate) is a property's annual net operating income (NOI) divided by its value, expressed as a percentage. It measures the return a property generates independent of how it's financed. Formula: Cap Rate = Annual NOI ÷ Property Value × 100.
What is a good cap rate for a rental property?
A good cap rate depends on the market and your goals. Generally: 3–5% in high-demand coastal markets (NYC, LA, Miami); 5–8% in most US suburban markets; 8–12%+ in lower-cost Midwest or rural markets. Higher cap rates mean more income relative to price but may signal slower appreciation or higher risk.
How do you calculate cap rate?
Step 1: Calculate annual gross rent (monthly rent × 12). Step 2: Subtract annual operating expenses (property tax, insurance, maintenance, vacancy, management) — but not mortgage payments. Step 3: The result is your NOI. Step 4: Divide NOI by the property value and multiply by 100. Example: $18,000 NOI on a $300,000 property = 6% cap rate.
What is the difference between cap rate and cash-on-cash return?
Cap rate ignores financing — it measures a property's income as if you paid all cash. Cash-on-cash return accounts for your mortgage and measures actual cash flow relative to the cash you put in. Two investors buying the same property can have the same cap rate but very different cash-on-cash returns based on their loan terms.
Can a rental property have a high cap rate and negative cash flow?
Yes. Cap rate doesn't include mortgage payments. A property with a 7% cap rate but a high interest rate loan could still produce negative cash flow after debt service. Always calculate both cap rate and monthly cash flow to get a complete picture of a deal.