What a cap rate actually measures
Divide one year of net operating income by the price of the property. That's the capitalization rate, and that's all it is: the yield the building throws off, as a percentage, assuming you bought it outright and nothing changes.
That assumption is on purpose. Because it ignores how the purchase was financed, the cap rate is the one number you can compare across two buildings bought by two different investors on two completely different loans. Take the debt out and what's left describes the asset: how much income it produces for what it costs.
So a cap rate isn't a return you'll personally collect. It's a price signal, the market's opinion of what income is worth in this location, for this asset class, right now. Your actual return depends on your loan, your tax position and what the property does over the years you hold it. None of that shows up in the formula.
The mortgage doesn't belong in the cap rate
Net operating income is calculated before debt service, and the loan payment never enters it. Not the interest, not the principal, not the mortgage insurance. That rule is what makes the number mean anything at all.
Take two identical duplexes on the same street, each producing $18,000 of NOI on a $300,000 price. One buyer pays cash, the other puts 25% down. Both have a 6% cap rate, because the property is identical and the cap rate describes the property. The two buyers end up in very different places, and that difference shows up in the cash-on-cash figure.
Two other items stay out for the same reason. Depreciation is a deduction on paper, not cash leaving the building, and it depends on when and how the owner acquired the asset. Income tax depends on the owner's bracket, other income and entity structure. Both describe the taxpayer, not the property. This calculator has no field for either, which is the surest way to keep them out.
Vacancy is the gap between the listing and the ledger
A unit renting for $2,400 a month doesn't produce $28,800 a year. It produces that minus the weeks between tenants, minus the month you spent repainting, minus the tenant who left owing the last two weeks. Underwrite on full contract rent and you'll invent a cap rate that doesn't exist.
Gross scheduled income becomes effective gross income only after you subtract vacancy and credit loss. A 5% vacancy allowance is roughly eighteen days a year. That's optimistic for anything but a tight market with long-stay tenants. Property with a lot of turnover realistically runs 8% to 10%.
The hit to the headline number is smaller than the raw percentage suggests, because expenses charged as a share of income shrink along with it. It still decides deals. On the default inputs here, dropping the vacancy allowance to zero lifts the cap rate by about four tenths of a percentage point. At a 10% allowance the gap is closer to three quarters. That's often the difference between a deal that clears your hurdle and one that doesn't.
The CapEx reserve turns a good deal into an average one
Every seller's expense sheet lists taxes, insurance and management. Almost none list capital expenditure, because in any given year there may have been none. Then the roof turns thirty, and one line item eats three years of cash flow.
CapEx and maintenance are different lines. Maintenance is the faucet, the service call, the turnover paint. CapEx is the roof, the furnace, the water heater, the windows and the parking surface, items that fail on a schedule of decades and cost thousands when they go. They're certain. Only the timing is unknown. Leaving them out doesn't make them cheaper. It moves the cost from your spreadsheet to your bank account.
The common rule is to reserve 5% to 10% of collected rent, more for older buildings and less for new construction still under warranty. This one line does more than any other to open the gap between an advertised cap rate and the one the property delivers.
Read it backward: price = NOI ÷ cap rate
Rearrange the formula and it prices a deal instead of describing one. If a property nets $18,000 and you need a 7% return for the risk, the most you can pay is $257,143. At 6% the same income supports $300,000. At 5%, $360,000.
Two things follow. First, this is how income property gets valued in practice: an appraiser or a buyer takes the market cap rate for the submarket and divides. Second, every dollar you add to NOI is worth many times itself in price. At a 6% cap rate, cutting $1,200 a year of expenses adds $20,000 of value. That multiplier is why running a property better matters so much more in commercial real estate than in a house.
Do this before you make an offer. Underwrite the income yourself, pick the return the risk deserves, and let the arithmetic give you a number, instead of negotiating against the asking price.
A high cap rate is a price for risk
Cap rates move opposite to price, so a high one means the market pays less for each dollar of income. There's always a reason. A 12% cap rate in a shrinking neighborhood, on a fifty-year-old building with month-to-month tenants, can be a lot worse to own than 5% on a stabilized property in a market with a waiting list.
The higher number is usually paying you for some mix of weak tenants, rent that won't grow, a building whose CapEx bill is already due, a market losing population, and an exit where the next buyer wants an even higher cap rate. That last one is the risk that hurts: buy at 12%, sell at 14%, and the property's value can fall while its income rises.
Comparing cap rates across cities without adjusting for that risk is the mistake under most bad out-of-state purchases. The number looked better because it was supposed to.
Cap rate vs. cash-on-cash vs. total return
People use these interchangeably, and they answer completely different questions.
| Formula | Answers | |
|---|---|---|
| Cap rate | NOI ÷ price | What is this property worth, independent of financing? |
| Cash-on-cash | cash flow after debt ÷ cash invested | What is my money earning this year? |
| Total return | cash flow + principal paid + appreciation | What did I actually make over the hold? |
Leverage is what separates the first two. Borrow below the cap rate and cash-on-cash rises above it. That's positive leverage. Borrow above it and cash-on-cash drops below the cap rate, and it can go negative while the building itself is perfectly sound. That's why the financing box in this calculator is fenced off: it changes the second number and must never touch the first.
How a listed cap rate gets inflated
- Full contract rent with no vacancy is the most common adjustment in any marketing package. It's worth a few tenths of a point in a tight market and closer to a full point where turnover is high.
- Pro-forma rents get used instead of actual ones: the income a broker believes the property could earn after improvements, shown as if it already does.
- The CapEx reserve is missing. That's quiet, easy to defend with "there were no capital projects last year", and worth roughly another four tenths of a point.
- Management is left out because the current owner does it personally. Your time isn't free, and if you ever stop, the expense shows up.
- The price leaves out closing costs. Real acquisition cost includes transfer tax, legal fees and any immediate repairs. Those don't change the cap rate, but they absolutely change what your money earns.
Rebuild the number from the actual tax bill, the actual insurance quote and a realistic vacancy figure before you compare it to anything. Everything in this tool stays in your browser. Nothing is uploaded, nothing is logged and there's no account.
Frequently asked questions
Does the mortgage payment count against the cap rate?
No, and getting this wrong is the most common mistake on the subject. Net operating income is calculated before any debt service, because the cap rate describes the property, not whatever loan you got on it. The same building has the same cap rate whether you pay cash or borrow 80% of the price. Once you subtract a mortgage payment you're no longer computing a cap rate. You're computing something closer to cash flow, and you can't compare it against any other listing.
What is a good cap rate?
No single number works everywhere, because a cap rate is a price for risk. Stabilized apartments in a strong metro trade in the 4% to 5% range. Secondary markets, older buildings and single-tenant retail with weak tenant credit sit higher. A 12% cap rate isn't automatically a better buy than a 5% one. It usually means the market doubts the rent will still be there in five years. Compare a cap rate only against other properties of the same type, in the same submarket, underwritten the same way.
Are repairs and CapEx the same thing?
No. Repairs are the running cost of keeping the unit livable this year: a leaky faucet, a service call, turnover paint. CapEx is the reserve for the big items that fail on a schedule of decades, like the roof, HVAC, water heater, windows and parking surface. Repairs almost always make it onto a seller's expense list. CapEx almost never does, which is why the reserve gets its own line in this calculator instead of being folded into maintenance.
Why is cash-on-cash different from the cap rate?
They divide different numbers by different numbers. The cap rate is NOI over the full purchase price. Cash-on-cash is cash flow after debt service over the cash you actually put in. Leverage pulls them apart. Borrow at a rate below the cap rate and cash-on-cash rises above it. Borrow above the cap rate and it falls below, and it can go negative while the property itself is perfectly healthy. Buy all cash with no closing costs and the two numbers match, which makes a handy sanity check.
Can I use the cap rate to work out what to offer?
Yes, and that's the most practical use of the formula. Rearranged, price equals NOI divided by cap rate. Underwrite the income yourself, decide what return the risk deserves, and the arithmetic gives you a maximum price instead of a reaction to the asking price. The calculator runs this in reverse for any target you type and shows how far that figure sits from what's being asked.