How to Calculate Capitalization Rate (Cap Rate) for Real Estate
Key Takeaways
- ✓ Cap rate = Net Operating Income (NOI) ÷ Property Purchase Price × 100.
- ✓ A 'good' cap rate varies by asset class — multifamily is 4–7%; industrial can be 5–8%.
- ✓ Cap rate ignores financing costs; it measures unlevered asset returns only.
- ✓ Higher cap rates signal higher risk, lower cap rates signal premium, stable assets.
Table of Contents
Capitalization Rate, commonly known as Cap Rate, is the single most critical metric used by commercial real estate investors, appraisers, and brokers to compare properties and estimate rate of return. It measures the unlevered yield of an asset over a one-year time horizon.
In simple terms, the Cap Rate tells you what your rate of return would be if you purchased a property entirely in cash, without using any debt (mortgage). Underwriting cap rates correctly is essential because it allows investors to normalize property valuations across different debt structures.
The Cap Rate Formula
Calculating a cap rate is straightforward. You divide the property's annual Net Operating Income (NOI) by its current Market Value (or purchase price).
The Cap Rate Formula
Cap Rate = (Annual Net Operating Income / Property Value) × 100
Step 1: Calculate Net Operating Income (NOI)
The cap rate calculation is only as accurate as your Net Operating Income (NOI). NOI represents all the revenue generated by the property, minus its operating expenses.
1. Gross Potential Income (GPI)
Add up all rental income if the property were 100% occupied at market rates.
2. Vacancy and Credit Loss
Subtract an allowance for empty units or unpaid rent (typically 5% to 10% of GPI).
3. Other Income
Add secondary revenue streams like laundry facilities, parking fees, pet rent, or storage locker rentals. This yields the Effective Gross Income (EGI).
4. Operating Expenses
Subtract the costs required to run and maintain the property.
⚠️ CRITICAL: What is EXCLUDED from Operating Expenses?
Do NOT subtract the following from NOI:
- Debt Service: Mortgage principal and interest payments are personal capital structure options and do not affect the physical property's efficiency.
- Income Taxes: State and federal income taxes are investor-specific.
- Capital Expenditures (CapEx): Major structural replacements (e.g., a new roof or repaved parking lot) are depreciated over time rather than expensed immediately.
Asset Class Expense Ratio Rules of Thumb
Operating expenses vary dramatically based on the property type. When underwriting deals, real estate professionals rely on regional average Operating Expense Ratios (OER)—the percentage of gross income spent on operations:
| Property Type / Asset Class | Average Expense Ratio | Key Expense Drivers |
|---|---|---|
| Multifamily / Apartments | 45% – 50% | Common area utilities, property management, high turnover maintenance. |
| RV Parks & Campgrounds | 40% – 45% | Seasonal utility spikes, landscaping, guest management. |
| Self-Storage Facilities | 30% – 35% | Low maintenance, minimal utility requirements, automated gates. |
| Single-Tenant NNN Industrial | 15% – 20% | Tenant pays property taxes, insurance, and maintenance; landlord expenses are minimal. |
A Practical Valuation Example
Suppose you are looking at a 10-unit apartment building:
- Asking Price: $1,500,000
- Annual Rental Income: $180,000
- Other Income (Laundry): $5,000
- Vacancy Rate: 5% ($9,000 loss)
- Annual Operating Expenses: $82,000 (management, taxes, insurance, repairs)
Let’s calculate the NOI:
Effective Gross Income (EGI) = $180,000 + $5,000 - $9,000 = $176,000 EGI
Net Operating Income (NOI) = $176,000 - $82,000 = $94,000 NOI
Now, we calculate the Cap Rate:
Cap Rate = ($94,000 / $1,500,000) × 100 = 6.27%
Buying this property cash yields a return of 6.27% on your capital.
What is a Good Cap Rate?
There is no single "good" cap rate. Cap rates are a reflection of risk:
- Low Cap Rates (4% – 5%): Typical for high-demand, low-risk areas (e.g., class-A apartments in coastal cities). These assets hold value but offer lower cash-flow returns.
- High Cap Rates (7% – 9%+): Found in higher-risk markets (e.g., class-C commercial buildings in rural regions or cities with declining populations). These assets cash-flow heavily but risk higher vacancy and little capital appreciation.
Accelerate Property Depreciation with Cost Segregation
Boost after-tax net operating yields by accelerating 20-30% of your commercial property basis into year-one write-offs.
Asset Class Cap Rate Calculators
Evaluate cap rates and operating expense ratios across specific property types:
Market Cap Rate Benchmarks by City and Asset Class (2025–2026)
Market cap rates vary enormously by geography and asset type. Institutional-grade assets in gateway cities trade at very low cap rates (high price/NOI ratios), while secondary and tertiary markets offer higher cap rates reflecting higher perceived risk and more available supply.
| Market / City Type | Multifamily | Office | Industrial | Retail Strip |
|---|---|---|---|---|
| Gateway (NYC, LA, SF) | 3.5–4.5% | 5.5–7.5% | 4.0–5.0% | 5.0–6.5% |
| Major Sun Belt (Atlanta, Austin, Tampa) | 4.5–5.5% | 6.0–7.5% | 5.0–6.0% | 5.5–7.0% |
| Midwest / Secondary (Columbus, Indianapolis) | 5.5–6.5% | 7.0–9.0% | 5.5–6.5% | 6.5–8.5% |
| Tertiary / Rural Markets | 7.0–10%+ | 8.0–12%+ | 7.0–10% | 8.0–12% |
Source: CBRE Cap Rate Survey H1 2026 (estimates). Cap rates are market-wide averages and vary significantly by property quality, lease terms, and specific submarket.
Cap Rate Compression vs. Expansion: The Investment Cycle
Understanding what drives cap rates up or down is essential for timing investment decisions:
Cap Rate Compression (Prices Rising)
When more capital chases a limited supply of commercial real estate, investors accept lower cap rates to secure deals. Cap rate compression typically occurs during: low interest rate environments; high-volume institutional buying; and periods of strong rent growth expectations. Gateway city cap rates compressed from 6–7% in 2010 to 3.5–4.5% by 2022 as a result of historically low interest rates.
Cap Rate Expansion (Prices Falling)
When interest rates rise or investor sentiment weakens, buyers demand higher returns (higher cap rates), meaning they pay less for the same NOI. Cap rate expansion was significant in 2023–2024 as the Federal Reserve raised rates from near-zero to 5.25–5.5%. Office properties saw cap rates expand by 150–200 basis points during this period.
💡 The 10-Year Treasury Relationship
Commercial real estate cap rates historically track approximately 150–250 basis points above the 10-Year US Treasury yield. This is the “spread.” When the Treasury yield is 4.5%, a typical stabilized multifamily deal might trade at a 5.5–6.5% cap rate. Monitoring this spread helps you assess whether commercial real estate is overpriced or underpriced relative to risk-free alternatives.
NOI Sensitivity: How Small Changes in Rent and Expenses Impact Value
Because commercial property value is derived from NOI ÷ cap rate, even small changes in operating income have a dramatically amplified effect on value. This table shows the value impact of a $10,000 change in NOI at various cap rates:
| Cap Rate | Value of $10k More NOI | Implication |
|---|---|---|
| 4.0% | $250,000 | Gateway markets amplify every rent increase massively |
| 5.5% | $181,818 | Mid-tier markets still reward NOI growth strongly |
| 7.5% | $133,333 | Secondary markets: less leverage from NOI improvements |
| 10.0% | $100,000 | Tertiary markets: value appreciation is more muted |
Run the Numbers with Default Averages
Compare cap rates and estimate operating expense ratios across 12 distinct asset classes using our free app.
Go to Cap Rate Calculator →Last reviewed: August 2026 · Sources: CBRE Cap Rate Survey H1 2026; Federal Reserve H.15 Selected Interest Rates; NCREIF Property Index.