Real Estate Cap Rate Calculator
What is Capitalization Rate (Cap Rate)?
The Capitalization Rate, or "Cap Rate," is one of the most fundamental metrics used in commercial and residential real estate investment. It represents the expected rate of return on a real estate investment property based on the income the property is expected to generate.
Essentially, the Cap Rate measures the yield of a property over a one-year time horizon, assuming the property is purchased with cash (without financing). It allows investors to compare the relative value and risk of different properties regardless of their price point.
How to Calculate Cap Rate
The formula for calculating Cap Rate is straightforward but requires accurate inputs regarding the property's income and expenses:
Where:
- Net Operating Income (NOI): This is the annual income generated by the property after deducting all operating expenses (taxes, insurance, maintenance, property management fees) but before deducting mortgage payments or capital expenditures.
- Current Market Value: This is the present purchase price or the current appraised value of the property.
Example Calculation
Let's look at a realistic scenario to understand how the math works:
- Property Price: $500,000
- Monthly Rent: $4,500
- Annual Expenses: $15,000
First, calculate the Gross Annual Income: $4,500 × 12 = $54,000.
Next, calculate the NOI: $54,000 (Income) – $15,000 (Expenses) = $39,000.
Finally, divide NOI by the Price: $39,000 / $500,000 = 0.078.
Result: The Cap Rate is 7.8%.
What is a "Good" Cap Rate?
There is no single "good" Cap Rate, as it depends heavily on the risk level of the asset and the current economic environment. However, generally speaking:
- 4% – 6%: Often seen in high-demand, low-risk areas (Class A properties in major cities). These properties appreciate well but offer lower immediate cash flow.
- 6% – 8%: A balanced range often found in suburban areas or stabilized commercial properties.
- 8% – 12%+: Higher risk properties, often in developing areas or older buildings requiring more maintenance. These offer higher cash flow to compensate for the increased risk.
Use the calculator above to quickly assess rental properties and filter out deals that don't meet your minimum return thresholds before diving deeper into due diligence.