What Is a Cap Rate?

The cap rate is real estate's simplest yield number: the income a property produces in a year, divided by its price. Learn the definition, the formula, and how to read the percentage like an investor.

A cap rate (capitalization rate) is the annual net operating income of a rental property divided by its price or value, expressed as a percentage. A $200,000 property with $12,000 of annual net operating income has a 6% cap rate: it earns 6 cents of operating income per year for every dollar of price.

The definition, in one sentence

Cap rate is short for capitalization rate. It answers one question: for every dollar of price, how much operating income does this property produce in a year? Divide the annual net operating income (NOI) by the price, and you have it. Unlike most investment ratios, there is no financing math, no tax math, and no appreciation guesswork. That is exactly why investors trust it for quick comparisons.

The formula

Cap rate = (annual net operating income / property price) x 100. NOI is the rent and other income the property brings in, minus operating expenses such as taxes, insurance, maintenance, management, and vacancies. Mortgage payments, income taxes, and depreciation are deliberately left out, because the cap rate is meant to describe the property, not the buyer's loan.

A worked example

Take a duplex listed at $200,000. It collects $24,000 a year in rent and loses $12,000 to taxes, insurance, maintenance, vacancies, and management. The NOI is $12,000. Divide $12,000 by $200,000 and multiply by 100: the cap rate is 6%. In plain English, the property pays you 6 cents of operating income per year for every dollar you pay for it. You can check the arithmetic instantly with our free cap rate calculator.

What a cap rate actually tells you

The percentage is shorthand for the market's verdict on risk and return. A low cap rate (4% to 5%) means investors accept a thin yield because they trust the income: prime location, newer building, strong tenants. A high cap rate (8% to 10%) means the market demands a thick yield to compensate for risk: older building, weaker location, shaky rent rolls. The same dollar of income simply costs less when the market is nervous about it.

This is why investors never judge a cap rate in isolation. A 5% cap rate on a newer apartment building in a growing city is unremarkable. A 5% cap rate on a 60-year-old building in a flat market would be a warning sign: the market should be demanding more yield for that risk, so the price is probably too high.

What it does not tell you

A cap rate is a snapshot of today, and three important things are missing from it. First, financing: it says nothing about your mortgage payment, so two buyers can pay the same price and earn very different cash returns. Second, growth: a property with rising rents can be a better buy at a 5% cap rate than a declining one at 8%. Third, total return: appreciation, tax benefits, and principal paydown are all outside the formula. For the financing piece, see our guide to cash-on-cash return; for the income side, see how NOI is calculated.

Quick reference: reading the percentage

Use these as rough US screening bands for stabilized rental property, not as verdicts. Below 4%: prime, low-risk assets where buyers pay for safety. 4% to 6%: strong markets, steady demand. 6% to 8%: the healthy middle for most residential rentals. 8% to 10%: above-average yield with above-average risk. Above 10%: expect heavy value-add work, distress, or numbers that need verifying. For the full breakdown, read our guide to the cap rate formula and how to solve it in any direction.

Check a cap rate in seconds

Have a property in mind? Enter the NOI and price and our free calculator returns the cap rate, the monthly NOI, and the price-to-income multiple, or works backwards from a target rate to the price.

Try the free cap rate calculator

Cap rate definition questions

What does cap rate stand for?

Cap rate is short for capitalization rate. In real estate, it is the ratio of a property's annual net operating income to its price or value, expressed as a percentage. A 6% cap rate means the property earns 6 cents of operating income per year for every dollar of price.

What is a 6% cap rate in real estate?

A 6% cap rate means the property generates net operating income equal to 6% of its price each year. For example, a $250,000 property with $15,000 of annual NOI has a 6% cap rate. It is a solid middle-of-the-road yield for residential rentals in many US markets.

Does the cap rate include the mortgage?

No. The cap rate is calculated before financing: it uses net operating income (income minus operating expenses, before mortgage payments) divided by price. That way the number describes the property itself, not the buyer's loan terms. Your own cash return with a mortgage is the cash-on-cash return, a separate metric.

Is a higher cap rate better?

A higher cap rate means more income per dollar of price, but it usually signals more risk: weaker locations, older buildings, or less reliable tenants. Within one market and property type, judge whether the extra yield pays for the extra risk rather than chasing the highest number.

What is the difference between cap rate and ROI?

Cap rate is one specific kind of return: annual net operating income divided by price, ignoring financing and appreciation. ROI is a broader term that can include the down payment, mortgage costs, tax effects, and price growth over the holding period. Investors use cap rate to compare properties and ROI to judge their own deal.