What Is Cap Rate? A Simple Explanation for Investors

Definition: what cap rate actually measures

Capitalization rate — cap rate — is the annual return a property produces on its purchase price, before any financing. It answers one question: if you paid cash for this building, what percentage of your money would come back each year from operations?

Because it strips out loans, cap rate is a property-level metric, not an investor-level one. Two buyers with wildly different mortgages looking at the same building will calculate the same cap rate. That is what makes it useful for comparison and useless for judging your personal return.

The formula

Cap rate = Net Operating Income ÷ Purchase Price (or current market value), expressed as a percentage.

Example: a property producing $24,000 of net operating income, bought for $325,000, has a cap rate of 24,000 ÷ 325,000 = 7.4%. If you paid $400,000 for the same income, the cap rate falls to 6.0%. Price and cap rate move in opposite directions — which is why sellers quote cap rates on optimistic income and buyers recalculate them on real income.

What counts as NOI

Net operating income is gross rental income plus other income, minus vacancy loss and all operating expenses. Operating expenses include property taxes, insurance, property management, maintenance and capital reserves, HOA dues, utilities you pay, and licensing or turnover costs.

What does not belong in NOI: mortgage principal and interest, depreciation, income taxes, and one-time rehab costs. Mortgage payments are the most common mistake — including them collapses cap rate into something closer to cash flow and makes properties impossible to compare.

Be honest about vacancy and reserves. A pro forma with zero vacancy and no maintenance line is not an NOI, it is a marketing number.

Why cap rate ignores financing

Financing is a fact about you, not about the building. Your credit, down payment, and rate change your cash flow dramatically while the property's income stays identical. By excluding debt, cap rate isolates the asset so you can compare a duplex in Ohio against a single-family in Texas on equal terms.

The tradeoff: cap rate cannot tell you whether a deal cash flows after your specific loan. A 7% cap property can lose money monthly at an 8% interest rate with 10% down. That is what cash-on-cash return is for.

Calculate yours

Enter purchase price, rent, and your real operating expenses in the Field ROI calculator and it computes NOI, cap rate, cash-on-cash return, and monthly cash flow at the same time — so you see both the property view and your view of the same deal.