Cap Rate Calculator for Income Property
Determine the profitability of your real estate investment by calculating the Capitalization Rate (Cap Rate) based on your Net Operating Income and Property Value.
How to Calculate Cap Rate for Income Property
The Capitalization Rate, or "Cap Rate," is a fundamental metric used by real estate investors to evaluate the potential return on an investment property. It represents the yield of a property over a one-year time horizon assuming the property is purchased with cash.
The Cap Rate Formula
To calculate the cap rate, you need two primary figures: the Net Operating Income (NOI) and the current market value (or purchase price) of the property. The formula is as follows:
Step 1: Determine Net Operating Income (NOI)
NOI is the total income generated by the property minus all necessary operating expenses. Crucially, NOI does not include mortgage payments (debt service), depreciation, or income taxes.
- Gross Income: Total potential rent plus other income (vending, parking).
- Operating Expenses: Property taxes, insurance, maintenance, property management fees, and utilities.
Step 2: Identify the Property Value
If you are looking to buy, use the asking price or your offer price. If you already own the property, use the current fair market value based on recent comparable sales in the area.
Suppose you are looking at a fourplex priced at $800,000.
– Annual Rental Income: $84,000
– Annual Expenses (Taxes, Insurance, Repairs): $24,000
– NOI = $84,000 – $24,000 = $60,000
– Cap Rate = ($60,000 / $800,000) × 100 = 7.5%
Why Cap Rate Matters
Cap rates allow investors to quickly compare different properties in different markets. A "good" cap rate depends on the asset class and location. Generally, a higher cap rate indicates a higher potential return but often comes with higher risk (e.g., an older building in a struggling neighborhood). Conversely, a lower cap rate usually suggests a safer investment in a high-demand area.
Limitations of Cap Rate
While useful, cap rate should not be the only metric you use. It does not account for leverage (mortgages), the time value of money, or future appreciation. For a more comprehensive view, investors also look at Cash-on-Cash Return and Internal Rate of Return (IRR).