Cap Rate

What is cap rate?

The capitalization rate, or cap rate, is the most widely used yardstick for comparing income-producing real estate. It answers a simple question: if you bought this property with all cash, what percentage return would its net operating income (NOI) deliver each year? Because it ignores mortgages entirely, cap rate lets you compare properties on equal footing regardless of how each buyer finances them.

A higher cap rate means more income per dollar of price, which usually reflects more risk: older buildings, weaker markets, or less reliable tenants. A lower cap rate signals a safer, more in-demand asset where investors accept less yield. In the mid-2020s, stabilized single-family rentals in the U.S. typically traded around 5% to 7%, while properties in fast-appreciating coastal markets often traded below 5%.

Cap rate is a snapshot, not a forecast. It says nothing about appreciation, loan paydown, tax benefits, or future rent growth, so investors pair it with metrics like cash-on-cash return and IRR to see the full picture.

Worked example

A rental house costs $200,000 and collects $21,600 a year in rent. After $7,600 of operating expenses (taxes, insurance, management, maintenance, vacancy allowance), NOI is $14,000. Cap rate = $14,000 ÷ $200,000 = 7.0%.

Frequently asked questions

What is a good cap rate for a rental property?

Most buy-and-hold investors look for cap rates between 5% and 8% for stabilized U.S. rental properties, but "good" depends on the market and the risk. A 4.5% cap rate can be reasonable in a fast-growing metro with strong appreciation, while an 8%+ cap rate in a declining market may not compensate for vacancy and maintenance risk. Compare a property’s cap rate against recent sales of similar properties in the same submarket rather than a national number.

Does cap rate include mortgage payments?

No. Cap rate is calculated from net operating income, which deliberately excludes mortgage principal and interest. That is what makes it useful for comparing properties independent of financing. To measure the return on the actual cash you put in after loan payments, use cash-on-cash return instead.

Why do lower cap rates mean higher prices?

Price and cap rate move in opposite directions because cap rate is income divided by price. If investors are willing to accept a 5% yield instead of 7% for the same NOI, they are effectively bidding the price up. That is why cap rate "compression" is good news for existing owners (their property is worth more) and bad news for new buyers hunting for yield.

Related tools and guides

• Rental Property Calculator
• Real Estate Investment Calculator