How to Calculate Cap Rate
Cap rate is one of the most common metrics investors use to compare rental properties. This guide explains what cap rate is, how to calculate it by hand, and how to use the Cap Rate Calculator in PropertyTools AI.
1. Understand net operating income (NOI)
Cap rate starts with net operating income, or NOI. NOI is your annual rental income minus annual operating expenses, before debt service. Operating expenses include property taxes, insurance, utilities you pay, maintenance, management, HOA dues, and an allowance for vacancy and repairs.
For example, if a property generates $30,000 in rent per year and you spend $10,000 on operating expenses, your NOI is $20,000.
2. Use the cap rate formula
The basic cap rate formula is straightforward:
Cap Rate = NOI ÷ Purchase Price
If your NOI is $20,000 and the property costs $300,000, the cap rate is about 6.67% ($20,000 ÷ $300,000). Higher cap rates typically indicate higher potential returns and higher risk, while lower cap rates are more common in premium, supply‑constrained markets.
You can run this calculation instantly with the Cap Rate Calculator by entering your expected annual rent, expenses, and purchase price.
3. Use cap rate for comparison, not perfection
Cap rate is most useful for comparing properties to each other, not for predicting exact returns. It does not include financing, income taxes, or long‑term appreciation, and it assumes your expense and rent estimates are accurate.
Use the cap rate as a first‑pass filter: for example, you might only consider properties at 6% cap rate or higher in a given market. Then use deeper tools such as the Property Investment Analyzer or ROI Calculator to model financing and long‑term returns.
Calculate cap rate for your next deal
Ready to run the numbers? Start with NOI and purchase price, then refine your assumptions as you learn more about each property.