Quick answer
Cap rate is a rental investing metric calculated by dividing net operating income by property value or purchase price. Investors use it to compare income-producing properties before financing, taxes, and owner-specific factors.
A higher cap rate does not automatically mean a better investment. Risk, location, condition, tenant quality, expenses, and growth potential also matter.
Cap rate formula
The common formula is:
Net operating income divided by property value equals cap rate.
If a property has $20,000 in annual NOI and is valued at $400,000, the cap rate is 5%.
What cap rate tells investors
Cap rate helps compare income performance across properties. It can show how much operating income a property produces relative to value.
It is especially useful when comparing similar properties in similar markets.
What cap rate does not include
Cap rate usually does not include mortgage payments, loan terms, income taxes, depreciation, or owner-specific financing.
It also does not fully capture repair risk, appreciation, tenant quality, or neighborhood trajectory.
How owners should use it
Use cap rate as one metric, not the whole investment decision. Pair it with cash flow, rent comps, maintenance reserves, property condition, and local market context.
Related resources
- Rental Investing Terms category
- What is net operating income?
- What is rental property cash flow?
- Rental Revenue Calculator
- Rental Income and Pricing category
Frequently asked questions
Is a higher cap rate always better?
No. Higher cap rates can also reflect higher risk, weaker locations, deferred maintenance, or slower growth.
Does cap rate include mortgage payments?
Usually no. Cap rate typically uses NOI before debt service.
Is cap rate the same as cash-on-cash return?
No. Cash-on-cash return considers cash invested and cash flow after financing.
Can cap rate change over time?
Yes. It can change when income, expenses, property value, or market conditions change.