The Capitalization Rate, or "Cap Rate," is one of the most fundamental metrics used in real estate investing to evaluate the profitability and return potential of an investment property. Unlike a simple Cash-on-Cash return, the Cap Rate measures the property's natural rate of return assuming the property was purchased entirely with cash, removing the impact of mortgage financing.
How to Calculate Cap Rate
To calculate the Cap Rate, you need to determine the Net Operating Income (NOI) and divide it by the property's current market value or purchase price.
The Formula: Cap Rate = (Net Operating Income / Property Asset Value) × 100
Step-by-Step Calculation Guide
Calculate Gross Income: Multiply monthly rent by 12 to get the annual potential income.
Adjust for Vacancy: Subtract expected losses due to vacancy (typically 5-10%).
Determine Expenses: Sum up all operating expenses (taxes, insurance, maintenance, property management). Do not include mortgage payments.
Calculate NOI: Subtract operating expenses from the effective gross income.
Divide: Divide the NOI by the purchase price to get the decimal, then multiply by 100 for the percentage.
Real-World Example
Imagine you are looking at a duplex listed for $500,000.
Rental Income: The two units generate $4,500/month combined ($54,000/year).
Vacancy: You estimate a 5% vacancy rate ($2,700/year loss).
Operating Expenses: Property taxes, insurance, and repairs cost $15,000/year.
NOI: $51,300 – $15,000 = $36,300.
Using the calculator above: ($36,300 / $500,000) = 7.26% Cap Rate.
What is a "Good" Cap Rate?
A "good" Cap Rate is subjective and depends on the location and risk level of the asset. generally:
4% – 6%: Considered safe, usually in high-demand, low-risk areas (Class A properties). Value appreciation is often the goal here.
6% – 8%: A balanced return typical for many residential investment properties.
8% – 12%+: Higher cash flow but often comes with higher risk, older buildings, or less desirable locations (Class C properties).
Use this tool to quickly screen properties. If a seller's asking price results in a 3% Cap Rate but the market average is 6%, the property may be overpriced.
function calculateCapRate() {
// Get input values
var priceStr = document.getElementById('cr_property_price').value;
var rentStr = document.getElementById('cr_monthly_rent').value;
var expenseStr = document.getElementById('cr_annual_expenses').value;
var vacancyStr = document.getElementById('cr_vacancy_rate').value;
// Convert to floats
var price = parseFloat(priceStr);
var monthlyRent = parseFloat(rentStr);
var annualExpenses = parseFloat(expenseStr);
var vacancyRate = parseFloat(vacancyStr);
// Validation: Ensure numbers are valid
if (isNaN(price) || isNaN(monthlyRent) || isNaN(annualExpenses) || isNaN(vacancyRate)) {
alert("Please enter valid numbers in all fields.");
return;
}
if (price <= 0) {
alert("Property price must be greater than zero.");
return;
}
// 1. Calculate Gross Annual Income
var grossAnnualIncome = monthlyRent * 12;
// 2. Calculate Vacancy Loss
var vacancyLoss = grossAnnualIncome * (vacancyRate / 100);
// 3. Calculate Effective Gross Income
var effectiveGrossIncome = grossAnnualIncome – vacancyLoss;
// 4. Calculate Net Operating Income (NOI)
var noi = effectiveGrossIncome – annualExpenses;
// 5. Calculate Cap Rate
var capRate = (noi / price) * 100;
// Formatting currency and percentage
var formatter = new Intl.NumberFormat('en-US', {
style: 'currency',
currency: 'USD',
});
// Display Results
document.getElementById('results-area').style.display = 'block';
document.getElementById('res_gross_income').innerText = formatter.format(grossAnnualIncome);
document.getElementById('res_vacancy_loss').innerText = formatter.format(vacancyLoss);
document.getElementById('res_noi').innerText = formatter.format(noi);
document.getElementById('res_cap_rate').innerText = capRate.toFixed(2) + "%";
}