Real Estate Cap Rate Calculator
What is Capitalization Rate (Cap Rate)?
The Capitalization Rate, or "Cap Rate," is one of the most fundamental metrics in real estate investing. It is used to estimate the potential return on an investment property, regardless of how it is financed. Essentially, it calculates the rate of return on the property based on the income the property is expected to generate.
Cap Rate is particularly useful for comparing different investment opportunities. By stripping away financing costs (mortgages), investors can compare the raw profitability of a single-family home against a commercial building or a multi-unit apartment complex on an apples-to-apples basis.
How to Calculate Cap Rate
The formula for Capitalization Rate is relatively straightforward but requires accurate inputs to be meaningful:
Cap Rate = (Net Operating Income / Current Market Value) × 100
To use this formula, you must understand the components:
- Net Operating Income (NOI): This is the total annual revenue the property generates (rent) minus all necessary operating expenses (property taxes, insurance, maintenance, management fees). Importantly, NOI excludes mortgage payments and capital expenditures.
- Current Market Value: This is essentially the price you pay for the property or its current appraised value.
What is a "Good" Cap Rate?
There is no single percentage that defines a "good" Cap Rate, as it varies significantly by location, property type, and the current economic environment. However, general guidelines often suggest:
- 4% to 5%: Often associated with lower-risk assets in high-demand, prime locations (like downtown New York or San Francisco). While the return is lower, the asset is considered safer and more likely to appreciate.
- 6% to 8%: A common target for many residential real estate investors balancing risk and return.
- 8% to 10%+: Higher returns are typically found in riskier markets, older properties requiring more maintenance, or rural areas with lower potential for property appreciation.
Why Vacancy Rate Matters
Our calculator includes a field for Vacancy Rate because assuming 100% occupancy is a common mistake. In the real world, tenants move out, and units sit empty during turnover. A standard vacancy allowance (often 5% to 8%) ensures your NOI calculation reflects realistic income, preventing you from overestimating the property's profitability.