Real Estate Investing
Cap Rate Explained: Evaluating Rental Property Investments
What cap rate measures, when it is useful, and why comparing it across markets without adjusting for expense ratios misleads you.
Cap rate is NOI divided by price
Capitalization rate is the property net operating income divided by the purchase price, expressed as a percentage. A property generating $15,400 in NOI at a $265,000 price has a cap rate of about 5.8 percent. It is the return the asset produces if you paid all cash, which makes it the cleanest way to compare two buildings.
When cap rate helps and when it does not
Cap rate is most useful for comparing similar properties in the same market, or for tracking a single market over time. It is less useful across markets with very different expense structures, because a 6 percent cap rate in a high-tax, high-insurance market can produce less cash than a 5 percent cap rate in a low-cost one.
Always verify the NOI behind the cap rate
A quoted cap rate is only as honest as the NOI behind it. Brokers sometimes use pro forma rent, exclude management, or understate reserves. Rebuild NOI from your own assumptions before you trust the number, then compare the resulting cap rate to recent sales of comparable buildings.
Key takeaways
- Cap rate is NOI over price, independent of financing.
- Compare within a market, not blindly across markets.
- Rebuild NOI from your own assumptions before trusting a quoted cap rate.
Editorial Team
Rental Property Lab Editorial Team
Rental Property Lab Editorial Team creates practical educational resources, calculators, comparisons, and guides for rental property owners. Our content focuses on rental management, maintenance, improvements, products, and property financial analysis.
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