What Is the Cap Rate Formula?

The capitalization rate (cap rate) is the most widely used metric for evaluating commercial and multifamily investment properties. It measures the annual return a property generates relative to its purchase price, independent of financing. Cap rate is one of several key metrics in real estate investment analysis — it provides the property-level yield that anchors every other return calculation. The cap rate formula relies on a key intermediate value: Net Operating Income (NOI).

The cap rate calculation follows three steps:

Step 1 — Effective Gross Income (EGI): Gross rental income adjusted for expected vacancy losses. If a property generates $100,000 in annual rent with a 5% vacancy rate, EGI = $100,000 x (1 - 0.05) = $95,000.

Step 2 — Net Operating Income (NOI): EGI minus all operating expenses and property management fees. NOI is the income available to service debt and provide returns. Operating expenses include property taxes, insurance, maintenance, repairs, and utilities (if landlord-paid). NOI specifically excludes mortgage payments, capital expenditures, and income taxes. For a complete breakdown of the cash flow after debt service, see our rental property cash flow calculator.

Step 3 — Capitalization Rate: Cap Rate = NOI / Purchase Price. A property with $60,000 NOI and a $1,000,000 purchase price has a 6% cap rate.

Cap rate is the foundation of the income approach to valuation, used by appraisers and institutional investors (source: Appraisal Institute). The key advantage is that it strips away financing variables, allowing direct comparison between properties regardless of down payment, interest rate, or loan term. To see how financing affects your actual returns, use our cash-on-cash return calculator.

Interpreting cap rates: Higher cap rates indicate higher yield but typically come with more risk (secondary markets, older properties, higher vacancy). Lower cap rates reflect lower risk and are common in gateway cities with strong appreciation potential. Compare cap rates only within the same property type and market to avoid misleading conclusions.

How to Use This Calculator

1. Purchase Price — Enter the total acquisition cost of the property. Include any closing costs you want to factor into the price basis.
2. Annual Gross Rental Income — The total annual rent the property would generate at full occupancy. For multifamily, sum all unit rents for 12 months.
3. Vacancy Rate — The expected percentage of time units will be vacant. Use 5% for stable markets, 7-8% for average markets, and 10%+ for higher-risk areas or properties with frequent turnover.
4. Annual Operating Expenses — All recurring costs: property taxes, insurance, maintenance, repairs, utilities, landscaping, and any other operating costs. Do not include mortgage payments or capital reserves.
5. Property Management Fee — Typically 6-10% of effective gross income. Even if you self-manage, include this to see the true cost of ownership and compare fairly against professionally managed properties.

The calculator instantly shows your cap rate, NOI, and effective gross income. Compare the cap rate against market benchmarks and other properties in your pipeline to identify the strongest investment opportunities.