The Formula
Cap Rate = Net Operating Income ÷ Purchase Price
Both inputs are annual. NOI is rent collected after vacancy, minus the cost of operating the building. Price is either what you pay or what the property is worth today. A 6% cap rate means the building produces income equal to 6% of its price each year, the same way a bond's yield describes its coupon against what it costs.
Because the loan never enters the formula, two buyers looking at the same building compute the same cap rate, whether one pays cash and the other borrows 80%.
What Goes Into NOI
The numerator does all the work, and it is also where most cap rate errors start. The full build is in Net Operating Income Explained. The short version:
| Subtracted inside NOI | Left out of NOI |
|---|---|
| Vacancy and credit loss | Mortgage principal and interest |
| Property taxes | Depreciation |
| Insurance | Capital expenditures (roof, HVAC) |
| Property management | Income taxes |
| Repairs and maintenance | Owner's personal expenses |
| Owner-paid utilities |
Other income such as parking or laundry adds to the rent side. The four exclusions on the right all depend on who owns the building rather than on the building itself. The most common mistake is subtracting the mortgage payment. That turns cap rate into a financing number and makes it impossible to compare against any published benchmark, all of which are computed before debt.
The Duplex, Worked
I run the same $425,000 duplex across this site so the numbers agree wherever a reader lands. It rents for $3,800 a month.
Gross rent: $3,800 × 12 = $45,600
Vacancy (5%): $45,600 × 5% = $2,280
Operating expenses: $17,100
NOI: $45,600 − $2,280 − $17,100 = $26,220
Cap Rate = $26,220 ÷ $425,000 = 6.2%
The building earns $26,220 a year before any loan, which is 6.2% of its price. Nothing about the down payment, the rate, or the buyer's tax bracket is in that number.
Comparing Buildings of Different Sizes
The reason cap rate exists is to put buildings of different sizes on one axis. Two more deals show the mechanism.
A $350,000 single-family rental at $2,400 a month collects $28,800 of gross rent. After 5% vacancy ($1,440) and $9,904 of operating expenses (taxes $4,200, insurance $1,400, management $2,304, repairs $2,000), NOI is $17,456. $17,456 ÷ $350,000 = 5.0%.
An $800,000 fourplex at $1,500 a unit collects $72,000. After 7% vacancy ($5,040) and $28,400 of operating expenses (taxes $9,600, insurance $3,200, management $7,200, repairs $6,000, common-area utilities $2,400), NOI is $38,560. $38,560 ÷ $800,000 = 4.8%.
| Property | Price | NOI | Cap rate |
|---|---|---|---|
| Single-family | $350,000 | $17,456 | 5.0% |
| Duplex | $425,000 | $26,220 | 6.2% |
| Fourplex | $800,000 | $38,560 | 4.8% |
The fourplex produces the most NOI in dollars and the lowest yield on its price. Cap rate says the duplex buys the most income per dollar. It says nothing about which of the three is the better purchase, because it cannot see rent growth, the condition of the roof, or the loan.
What a Good Cap Rate Depends On
There is no single good cap rate, because cap rate is a price the market sets on risk as much as it is a return. A low cap rate means buyers are paying a lot for each dollar of current income, which they do when they expect that income to be stable or to grow. A high cap rate means the market is discounting something: an older building, a weaker submarket, shorter leases, or deferred maintenance.
So a cap rate only means something against the range for its property type, class, and market. The duplex's 6.2% sits above the 2025 Marcus & Millichap multifamily averages below. Whether that gap is a bargain or a warning depends on why the market priced it there. Current ranges by sector, class, and market tier are in What Is a Good Cap Rate?, which tracks the published surveys so this page doesn't have to repeat them.
Cap Rate Ranges by Property Type
Two published sources carry the numbers on this page, and both are dated. Marcus & Millichap's 2025 cap rate research brief reported these averages for the first quarter of 2025:
| Sector and class | Average cap rate (Q1 2025) |
|---|---|
| Multifamily Class A | 4.74% |
| Multifamily Class B | 4.92% |
| Multifamily Class C | 5.38% |
| Industrial Class A | 4.84% |
| Industrial Class C | 6.71% |
The same brief reported multifamily cap rates compressing 7 basis points and industrial 5 basis points during that quarter. CBRE's H1 2025 U.S. Cap Rate Survey reported its all-property cap rate estimate declining 9 basis points.
The pattern inside each sector is the useful part. Class C trades above Class B, which trades above Class A, because older buildings with weaker tenants carry more risk per dollar of income. Retail, office, and self-storage ranges, plus the adjustment by market tier, are in the benchmarks post.
What Moves Cap Rates
Four forces do most of the moving.
Location. Gateway cities trade at lower cap rates than smaller markets for the same property type, because deeper buyer pools, limited new supply, and a history of appreciation let buyers accept less current income.
Property class. Newer buildings in better locations with higher rents trade at lower cap rates. Older buildings with value-add work ahead trade higher.
Interest rates. Rates matter less directly than most people assume. Per the same Marcus & Millichap research, movements in the 10-year Treasury yield were only 40% correlated with movements in average apartment cap rates, while changes in the number of trades were 78% correlated with cap rate movements since 2001. Transaction volume tracked cap rates more closely than the Treasury did.
Market cycle. In an expansion, demand pushes prices up faster than income and cap rates compress. At the peak they are lowest. In a contraction, prices fall faster than income and cap rates expand, then stabilize in the recovery.
Running the Formula Backward
Cap rate also works as a valuation tool:
Value = NOI ÷ Cap Rate
Hold the duplex's NOI at $26,220 and change only the cap rate the market applies:
| Cap rate | Implied value | Change from 6.5% |
|---|---|---|
| 6.5% | $403,385 | |
| 6.0% | $437,000 | +$33,615 |
| 5.5% | $476,727 | +$73,342 |
| 5.0% | $524,400 | +$121,015 |
A 1.5-point drop in cap rate adds $121,015 of value, 30%, with no change in rent or expenses. That is the arithmetic behind the wealth that cap rate compression created in low-rate years, and the same arithmetic runs in reverse when cap rates expand.
It also explains why an NOI error is expensive. At a 6% cap, every $1,000 of NOI is $16,667 of price. A seller NOI overstated by $2,000 a year is a price overstated by $33,333.
The Trap: Cap Rate Ignores the Loan
Cap rate is an all-cash return. Almost nobody buys a rental with all cash, and the loan can turn a positive cap rate into a negative return on the buyer's money.
Finance the duplex with a $340,000 loan (80% of price) at 7% over 30 years. Annual debt service is $27,144.
Cash flow = $26,220 NOI − $27,144 debt service = −$924
Cash-on-cash = −$924 ÷ $85,000 down payment = −1.1%
The building yields 6.2%. The buyer's down payment earns −1.1%, and counting about $12,000 of closing costs, as the cash-on-cash calculator does, the $97,000 in the deal earns −1.0%. The reason is that the loan costs more per dollar than the building earns per dollar. $27,144 ÷ $340,000 is a 7.98% annual loan constant against a 6.2% cap rate. That is negative leverage, and it has an odd consequence: more cash down raises the return.
| Down payment | Loan | Debt service | Cash flow | Cash-on-cash |
|---|---|---|---|---|
| 20% ($85,000) | $340,000 | $27,144 | −$924 | −1.1% |
| 40% ($170,000) | $255,000 | $20,358 | $5,862 | 3.4% |
| 100% ($425,000) | $0 | $0 | $26,220 | 6.2% |
At all cash, cash-on-cash equals the cap rate. Every dollar of debt at a constant above the cap rate pulls the return down. The comparison is worked in full in Cap Rate vs Cash-on-Cash, and the cash-on-cash calculator runs it on your own loan terms.
Other Limits
One year only. Cap rate uses a single year of NOI. It cannot see rent growth, a lease rolling off next year, or the roof that needs replacing in three. Multi-year returns are what IRR measures.
Capital expenditures are invisible. NOI excludes capex by definition, so a building can post 6.2% and spend several years of that yield on one roof.
Pro forma NOI inflates it. An asking cap rate is often computed on the rent the seller believes the property could achieve, or on thin vacancy and expense assumptions. Drop the duplex's vacancy from 5% to zero and NOI rises to $28,500, a 6.7% cap on the same price. Recomputing on the trailing twelve months of collected rent and actual expenses is where the gap between an advertised cap rate and a real one shows up.
Value-add deals break it. On a building that is half vacant or rented well below market, the current cap rate describes the problem, not the investment. The number that matters is the stabilized cap rate after the work, which is a projection and carries a projection's risk.
Cap Rate Compared With Other Metrics
| Metric | Question it answers | Sees financing? |
|---|---|---|
| Cap rate | What does the building yield on its price? | No |
| Cash-on-cash return | What does my cash earn this year? | Yes |
| DSCR | Does the income cover the loan payment? | Yes |
| IRR | What is the return over the whole hold? | Yes |
| GRM | How many years of gross rent is the price? | No, and no expenses either |
Cap rate screens and compares buildings. The financed metrics decide whether a specific purchase works.
FAQ
What is the cap rate formula?
Cap Rate = Net Operating Income ÷ Purchase Price. On the $425,000 duplex, $26,220 ÷ $425,000 = 6.2%.
How do I calculate cap rate from monthly rent?
Annualize the rent, subtract vacancy and operating expenses to reach NOI, then divide by price. $3,800 a month is $45,600 a year. Less $2,280 of vacancy and $17,100 of expenses, NOI is $26,220, and the cap rate is 6.2%. Dividing monthly or gross rent by price produces a number that is not a cap rate.
What is the difference between cap rate and ROI?
Cap rate is one year of unlevered income against price, and it is the same for every buyer of the same building. ROI is broader and can include financing, appreciation, and tax effects, so it differs from buyer to buyer and hold to hold.
Is a higher cap rate always better?
No. A higher cap rate means more income per dollar of price, and usually more risk: a weaker location, an older building, or tenant problems. A high cap rate is the market pricing in something it does not like, and the useful question is what.
Does the price I use change the cap rate?
Yes, and that is the point of running it twice. At the $425,000 asking price the duplex is a 6.2% cap. At a $400,000 offer, $26,220 ÷ $400,000 = 6.6%. The spread between the two shows how much the price has to move to reach a given yield.
Where do current cap rate figures come from?
CBRE publishes a semi-annual U.S. Cap Rate Survey, and Marcus & Millichap publishes research briefs. Local commercial brokers have recent transaction data. LoopNet listings show asking cap rates, which are usually computed on the seller's numbers.
Related Reading
- What Is a Good Cap Rate?: current benchmark ranges by property type, class, and market tier
- Net Operating Income Explained: how the numerator gets built and which costs stay out of it
- Cap Rate vs Cash-on-Cash: why the two metrics disagree once a loan is involved
- Cash-on-Cash Return Guide: the return on the cash you actually put in
- Break-Even Occupancy Analysis: how much vacancy a deal can absorb
- NOI Calculator: build NOI line by line before dividing it by anything
Keep reading
- 1031 Exchange Rules: Timelines, Like-Kind Property and What Gets DeferredHow a 1031 exchange defers capital gains on a property sale: the like-kind and equal-value rules, the 45 and 180 day deadlines, and where exchanges fail.
- Break-Even Occupancy: How Empty a Rental Can Get Before It Loses MoneyThe break-even occupancy and break-even rent formulas for a rental property, worked with real numbers, and what the result says about risk and financing.
- The BRRRR Method: Buy, Rehab, Rent, Refinance, Repeat, With the MathHow the BRRRR method works step by step, how much cash the refinance actually returns, and where the numbers break when the appraisal comes in low.