What is a 'good' cap rate?

It depends entirely on the market and property class. In Class A urban multifamily (New York, San Francisco, Boston), 4–5% is standard. In Class B suburban, 6–7% is market. In Class C value-add or tertiary markets, 8–10%+ is expected. A high cap rate isn't automatically good — it usually reflects higher risk (worse location, older building, tenant turnover, deferred maintenance). A low cap rate isn't bad — it reflects low risk and strong appreciation expectations. Compare to local comparable sales.

Why doesn't cap rate include mortgage payments?

Because cap rate is the property's unlevered return — what it yields before any financing. This lets investors compare properties regardless of how each one is financed. One buyer might pay all cash; another might use 80% leverage. The cap rate is the same for both because it measures the asset's performance, not the buyer's financing structure. Cash-on-cash return is the levered version that does include mortgage payments; use our cash-on-cash calculator for that.

How does cap rate relate to property value?

Valuation formula: Property Value = NOI ÷ Cap Rate. If NOI is $30,000 and market cap rates are 6%, the property is worth $500,000. If cap rates compress to 5% (meaning buyers are willing to pay more for the same income), the property is worth $600,000. This is why rising interest rates hurt commercial real estate — they push cap rates higher, which pushes property values lower for the same income stream. Understanding this math is essential for investing beyond single-family homes.

Should I use actual NOI or pro-forma NOI?

Actual NOI (trailing 12 months) is the honest number. Pro-forma NOI is what the seller claims the property will generate after 'value-add' improvements. Listing agents always quote pro-forma because it makes the cap rate look higher. Never underwrite a deal based on pro-forma without doing your own stabilized-expense analysis. The most common mistake for new commercial investors is believing the seller's pro-forma and overpaying.

What's the difference between cap rate and yield?

Cap rate is a specific formula: NOI / purchase price. 'Yield' is a more general term that can refer to many metrics: gross yield (gross rent / price), net yield (NOI after debt service / price), cash yield, yield to maturity. For a commercial property, when someone says 'yield' they usually mean cap rate. For a residential property, 'yield' more often means gross or net rental yield. Our rental yield calculator distinguishes these explicitly.

Cap Rate Calculator | Real Estate Capitalization Rate

Cap rate: the single most important metric in commercial real estate

Capitalization rate — almost always shortened to "cap rate" — is how commercial real estate prices are set, how deals are compared across markets, and how value is created or destroyed in every commercial transaction. Unlike residential real estate, which is priced by comparable sales, commercial property is priced by capitalizing its income. The formula is brutally simple but the implications reach into every corner of investor returns.

This calculator takes you through the full cap rate build-up: gross scheduled income, vacancy, effective gross income, operating expenses, net operating income, and cap rate itself. Enter your property's numbers and you'll see exactly how each line feeds into the valuation math that institutional investors use every day.

The formula, and why it's powerful

Cap rate = Net Operating Income (NOI) ÷ Purchase Price. On a $450,000 property with $27,000 of annual NOI, cap rate is 6.0%. Rearranged: Property Value = NOI ÷ Cap Rate. Same $27,000 of NOI at a 5% cap rate = $540,000 valuation. At a 7% cap = $385,714.

This simple algebra is how commercial real estate responds to interest rates. When rates rise, required cap rates rise too (because investors demand higher returns to justify lower-risk alternatives). Same income stream, higher cap rate, lower value. The 2022–2024 Fed tightening cycle caused commercial real estate values to fall 20–30% in many markets — not because rents dropped, but because required cap rates rose from 4% to 5.5% or 5% to 6.5%.

Net operating income: the input that matters most

NOI is where cap rate analysis lives or dies. The formula:

Gross scheduled income. Total rent if every unit is fully occupied at full market rate.
Minus vacancy and concession losses. Realistic 5–10% haircut.
Plus other income. Pet rent, parking, laundry, late fees, utility reimbursements.
= Effective gross income (EGI).
Minus operating expenses. Property tax, insurance, maintenance, management, utilities, landscaping, payroll, admin.
= Net operating income (NOI).

Notably, NOI does notinclude: debt service (mortgage payments), depreciation, income taxes, or capital expenditures (capex). Cap rate is purely an operating metric on the asset, not a return on the investor's cash.

Operating expense benchmarks

The single biggest source of errors in cap rate analysis is under-reporting operating expenses. Sellers almost always show a cleaned-up expense line that ignores real costs. Use these benchmarks as a sanity check:

Property tax: 1–3% of assessed value. Will reassess after sale in most states — budget for this.
Insurance: 0.3–0.8% of replacement cost; spikes in disaster-prone markets.
Maintenance: 1% of property value per year as a floor; older buildings 1.5–2%.
Property management: 8–10% of EGI for residential; 4–6% for commercial; zero if self-managing.
Utilities (landlord-paid): highly variable; heating and water often reimbursed by tenants.
Reserves for capital expenditures: $250–$400 per unit per year. Many pro-formas omit this.

Total operating expenses typically run 40–50% of EGI for well-managed multifamily. Single-family rentals often show lower percentages (35–45%) because they have simpler expense structures. If a seller's pro forma shows expenses under 30% of EGI, that's a red flag — they've omitted something.

Cap rate by asset class and market

Typical 2025 cap rates by asset class (these move constantly):

Class A multifamily, coastal: 4.0–5.0%
Class A multifamily, sunbelt: 5.0–5.5%
Class B multifamily, suburban: 5.5–6.5%
Class C multifamily, value-add: 7.0–9.0%
Single-family rental, prime: 5.5–6.5%
Single-family rental, secondary: 7.0–9.0%
Retail, anchored strip: 6.5–7.5%
Retail, single-tenant net lease (Starbucks, CVS): 4.5–5.5%
Industrial: 5.5–6.5%
Office, Class A: 6.5–8.0% (higher post-COVID)
Self-storage: 6.0–7.0%
Hotels: 7.5–9.5%

Cap rate compression and expansion

Cap rates don't stay static. They move with capital markets, investor sentiment, and market fundamentals. Compression means cap rates are falling (values rising for same income). Expansion means cap rates are rising (values falling).

From 2010 to 2021, cap rates compressed dramatically across all asset classes. Multifamily that traded at 7% in 2010 was trading at 4% by 2021. Same NOI, 75% higher valuation, purely from cap rate movement. This was the single biggest driver of commercial real estate returns during that decade.

From 2022 forward, cap rates started expanding as the Fed raised rates. A 1% cap rate expansion on a 5% asset is a 20% drop in value. That's why a lot of commercial real estate bought at peak 2021 prices is now underwater.

Using cap rate to value a property

The practical use case: you're looking at a rental property. Research local cap rate comps — what have similar properties sold for relative to their NOI? If comps suggest 6% is the market cap rate and your property generates $30,000 NOI, the market value is $500,000. If the seller is asking $600,000, they're asking a 5% cap — the property needs to produce $36,000 NOI to justify the price, which means either (a) you can add value, (b) the local cap rate is lower than you thought, or (c) they're overpricing.

The inverse is how value-add investors create wealth: buy at market cap rate, increase NOI through rent growth or expense reduction, and sell at the same cap rate for a higher valuation. $500,000 at 6% cap → increase NOI from $30k to $36k → sell at 6% = $600,000. The $100,000 value creation came from $6,000 of annual NOI improvement.

Cap rate vs. cash-on-cash return

Cap rate is unlevered. Cash-on-cash is levered. If you buy a $500,000 property at a 6% cap rate ($30,000 NOI) all cash, your cash-on-cash return is 6%. If you finance 75% at 6.5%, your cash invested drops to $125,000 and your annual cash flow is $30,000 NOI minus roughly $29,000 mortgage = $1,000. Cash-on-cash is 0.8%.

Flip the rates: if you financed 75% at 4%, your mortgage would be $21,500 and cash flow would be $8,500 on $125,000 cash = cash-on-cash of 6.8%. Same asset, same cap rate, dramatically different investor returns because of leverage cost. See our cash-on-cash return calculator for the levered side of the math.

When cap rate misleads

Capex-heavy properties. An old building with a failing roof might show a 9% cap rate but need $150,000 of capex in year 1. The real cap rate after capital improvements is much lower. Always ask: what does this building need in the next 5 years?

Unsustainable income. A property with a single tenant on a short-term lease at above-market rent might show a high cap rate today, but when the tenant leaves, rent drops to market and the cap rate collapses. Always stress-test with market rents.

Below-market rents.The opposite: a property with long-term tenants paying well below market shows a low cap rate. But there's upside when those leases expire. This is the classic value-add setup.

Related tools

Run the levered version of return in our cash-on-cash return calculator. See gross vs. net yield breakdown in our rental yield calculator. Model the full investor package in our investment property calculator. Reality-check your income assumption with our rental vacancy impact calculator.

Cap rate calculator