Cap rate calculator

Cap rate — the clean yield metric for real estate

Cap rate (capitalization rate) is the yield a property generates on a cash-only, no-financing basis. It's the same number you'd compute for a bond: what's the annual income divided by the price? For real estate, the "annual income" is net operating income (NOI) — rent minus operating expenses, before debt service and before income taxes.

Cap rate = NOI / property value

What counts in NOI

NOI is the standard operating-income definition used across commercial real estate:

• Effective gross income — gross potential rent minus vacancy & collection losses plus any other income (laundry, parking, late fees).
• Minus operating expenses — property tax, insurance, management, maintenance, utilities owner pays, landscaping, pest control, HOA fees, professional services.

Crucially, NOI does not include: mortgage payments, depreciation, capital expenditures (in some definitions), income tax, or investor financing costs. These are all below-the-line items that vary by investor.

Capital expenditures: the NOI fight

Is a new roof an operating expense or a capital expenditure? Different investors use different conventions. Conservative underwriting includes a capex reserve (typically 5% of rent) in operating expenses. Aggressive (pro-forma) underwriting excludes capex, making NOI look higher. When you see a listing advertised at a 7% cap rate, always ask: is that NOI including or excluding capex reserves? The difference is often 1–2 percentage points of cap rate.

How cap rates price the market

Cap rates are set by the market, not by the investor. Institutional buyers (REITs, pension funds, insurance companies) have massive capital they need to deploy, and they'll bid prices up or down until cap rates align with their return requirements. Private investors typically follow the institutional cap-rate signal.

In any given market, cap rates cluster by property class:

• Class A — newer, luxury, prime location: 3.5–5.5% cap rates. Strong tenants, low turnover, low cash-flow risk — hence low yields.
• Class B — older but maintained, middle- income locations: 5–7%. Moderate risk, moderate yields.
• Class C — older, deferred maintenance, workforce housing: 7–10%. Higher yield to compensate for higher tenant-risk and higher maintenance cost.

Cap rate vs interest rate — the spread

Real estate competes with bonds for investor capital. Historically, cap rates trade 1–3 percentage points above 10-year Treasuries. When the 10-year Treasury is at 4.5%, a 5–6% cap rate is the "risk premium" the market demands for holding illiquid, tenant-dependent real estate instead of a liquid Treasury bond.

When Treasury rates spike, cap rates eventually follow. This is the math behind the 2022–2024 commercial real estate repricing — office, retail, and even multifamily saw cap rates rise 100–200 bps, which translated to 15–25% price drops.

Cap rate math across scenarios

The relationship is mechanical: price = NOI / cap rate. A 10 bp (0.10%) change in cap rate on a $1M NOI property changes the value by about $150,000–$400,000 depending on the starting cap. That's why cap-rate sensitivity is the single biggest variable in commercial real estate valuation.

The GRM shortcut

For small residential, investors often use gross rent multiplier (GRM) instead of cap rate: GRM = price / annual rent. A GRM of 10 means the price equals 10 years of rent. Low GRMs (4–6) usually correspond to high cap rates (9–12%), while high GRMs (15+) correspond to low cap rates (3–5%). GRM is faster to compute because it skips the operating-expense calculation, but it's less precise because it doesn't adjust for differing expense structures (HOA, taxes, etc).

When cap rate misleads

• Value-add deals — trailing cap rate is low because current rents are below market. Investors price the deal at the stabilized cap rate (what it will be after renovations and re-tenanting).
• Single-family — very small sample of rent data per property, higher relative management cost, amateur ownership. Cap rates computed on SFR often don't account for these.
• Short-term rentals — STR "cap rates" from Airbnb spreadsheets are typically overstated because they don't include cleaning, management, software, regulatory risk, and seasonal vacancy.