Accounting GnomeHow the cap rate is calculated
The capitalization rate measures a property's return independent of financing. The formula is:
Net operating income (NOI) is what's left after operating costs but before any mortgage payment:
Why exclude the mortgage?
Cap rate is meant to compare properties on equal footing, regardless of how each buyer finances them. Including loan payments would make the same building look different to a cash buyer versus a leveraged one. To factor in financing, look at cash-on-cash return and DSCR instead — both available in the full analyzer.
What is a good cap rate?
There's no universal answer — it's market- and risk-dependent. A stabilized property in a major metro might trade at a 4–5% cap, while a higher-risk or secondary-market property might be 8%+. The right benchmark is what comparable local properties sell for. A higher cap rate generally means more income relative to price (and often more risk).
Other metrics to check before buying
- Cash-on-cash return — annual pre-tax cash flow ÷ total cash invested.
- DSCR — NOI ÷ annual debt service; lenders typically want ≥ 1.25×.
- Gross rent multiplier (GRM) — price ÷ gross annual rent, a quick screening ratio.
- The 1% rule — monthly rent ≥ 1% of price as a rough first filter.