A cap rate (capitalization rate) is a property's net operating income divided by its price or value: cap rate = NOI ÷ price. It is the yearly return the property would earn if you bought it with all cash, before any loan. A house with $20,664 of NOI bought for $400,000 has a cap rate of 5.17%.
Because it leaves the loan out, a cap rate lets you compare properties on their own earning power, whatever financing each buyer uses. That is also its limit: it says nothing about what your own cash will earn once you borrow.
How do you calculate a cap rate?
- Start with a year of income. For a long-term rental, that is the rent for twelve months minus a vacancy allowance. For a short-term rental, it is the nightly rate times the nights booked.
- Subtract the operating expenses. Property taxes, insurance, HOA dues, management, repairs, a capital expenditure reserve, utilities you pay and, for a short-term rental, platform fees and supplies. Not the mortgage, not depreciation, not income taxes. Net operating income goes through every line.
- The result is NOI. Divide it by the purchase price (or the current value, if you already own it).
- Multiply by 100 for a percentage.
Cap rate on the sample house, both ways
The example deal used across these guides is a $400,000 single-family house, set out in full in how to analyze a rental property. The figures are assumptions for illustration, not a forecast.
| Long-term rental | Short-term rental | |
|---|---|---|
| Gross income | $36,000 | $72,000 |
| Vacancy | ($1,800) | In the nights booked |
| Operating expenses | ($13,536) | ($44,328) |
| Net operating income | $20,664 | $27,672 |
| Cap rate (NOI ÷ $400,000) | 5.17% | 6.92% |
The short-term version earns twice the gross but keeps far less of it, so its cap rate is only 1.75 points higher. Its biggest cost is the manager at $12,168 a year. Manage it yourself and NOI becomes $39,840, a 9.96% cap rate, but the extra return is a wage for the hours you put in, not a better property.
What is a good cap rate for a rental property?
There is no universal good number, because a cap rate is a price for risk. Three comparisons tell you whether one is good for you.
Against a safe yield
The 10-year Treasury yielded 4.91% on November 2, 2026. A rental at a 5.17% cap rate earns 0.26 points more than a government bond, for tenants, repairs, vacancies and money you cannot pull out in a day. Most investors want a wider gap than that unless they expect the value and rent to grow.
Against what your loan costs
Divide a year of loan payments by the loan amount. At an example 7.5% rate over 30 years, $25,171.68 a year on $300,000 is 8.39%. A cap rate above that figure means borrowing raises your return on cash. Below it, every borrowed dollar costs more than it earns, which is why both versions of the sample house return far less on cash than they do on price.
Against similar properties in the same market
Cap rates for single-family rentals commonly fall somewhere around 4% to 8%, and the reasons for the spread matter more than the range:
| Where the property sits | Common cap rates | Why |
|---|---|---|
| Expensive, high-demand metros | About 4% to 5.5% | Buyers pay for expected appreciation and steady demand |
| Mid-priced, steady markets | About 5.5% to 7% | Income and growth in balance |
| Lower-priced, slower-growth markets | About 7% to 9% or more | More income to make up for vacancy, repairs and weaker resale |
| Short-term rentals | Often a few points higher on paper | The revenue pays for running a small business and regulation risk |
These are broad patterns, not targets, and they move with interest rates. The useful test is narrower: is this house's cap rate higher or lower than similar rentals on similar streets, and why?
Purchase price or current value?
Use the purchase price when you are deciding whether to buy, because that is what the income is paying for. Once you own the property, use its current value to decide whether to keep it. Suppose the sample house were worth $440,000 two years from now, an assumption for illustration. The same $20,664 of NOI on that value is a 4.70% cap rate. The property earns exactly what it did, but the equity tied up in it now earns less, which is the question behind every decision to sell, refinance or trade into something else. Using the old price would show 5.17% and hide that.
Is a higher cap rate always better?
No. A high cap rate can mean a bargain, or it can mean the market sees risk you have not priced: an older house about to need a roof, a neighborhood with high turnover, rent that will not last, or a short-term rental in a city tightening its rules. It can also mean the NOI is overstated. Listing cap rates are often worked out with no vacancy, no management and no capex reserve, and with the seller's old tax bill. Rebuild the NOI yourself before you compare.
A low cap rate is not automatically bad either. Investors in fast-growing markets accept low cap rates because they expect rent and value to rise. That is a bet on growth, and it should be named as one.
Cap rate vs cash-on-cash return
| Cap rate | Cash-on-cash return | |
|---|---|---|
| Formula | NOI ÷ price | Cash flow after the loan ÷ cash invested |
| Counts the loan? | No | Yes |
| Best for | Comparing properties | Judging your own deal and financing |
| Sample house, long-term | 5.17% | (4.02%) |
| Sample house, short-term | 6.92% | 1.89% |
The gap between the two columns is the effect of the loan. On the sample house it works against you, because both cap rates sit below the 8.39% the loan costs each year. The cash-on-cash return is where you see what your $112,000 or $132,000 actually earns.
Neither measure includes appreciation, principal paydown or tax effects. Total return and internal rate of return (IRR) bring those in, at the price of more assumptions.
Using a cap rate to estimate value
Turn the formula around and value = NOI ÷ cap rate. If similar rentals trade at a 5.5% cap rate, the sample house's long-term NOI of $20,664 suggests a value of $375,709.09. At 5% it would be $413,280; at 6%, $344,400. The same math shows why NOI matters so much: at a 5.5% cap rate, every $1,000 of extra yearly NOI adds $18,181.82 of value.
For apartment buildings and commercial property, appraisers lean on this income approach. For houses and two to four units, the appraisal rests mainly on comparable sales, because most buyers of houses are people who will live in them. A cap rate is still a good way to sort the deals you see, but expect the rental property appraisal to come from sales of similar homes.
How do interest rates move cap rates?
When Treasury yields and mortgage rates rise, buyers need more income for each dollar they pay, so cap rates tend to rise. Higher cap rates on the same NOI mean lower prices. When rates fall, the reverse happens, which investors call cap rate compression. The 30-year fixed mortgage average was 7.24% at the end of October 2026, and investor loans usually price above it, so many single-family rentals that would have shown positive leverage a few years ago no longer do.
Lenders on rental loans mostly ignore the cap rate. A DSCR lender asks whether the rent covers the monthly payment, worked out in how to calculate DSCR. GoDoor's deal calculator shows the cap rate and the coverage ratio side by side.
Mistakes to avoid with cap rates
- Including the mortgage payment in expenses. That is cash flow, not NOI, and it makes the cap rate meaningless.
- Comparing a listing's cap rate, built on no vacancy and no reserves, with your own careful one.
- Using the current owner's property taxes when the sale will trigger a reassessment.
- Comparing a short-term rental's cap rate with a long-term rental's without asking who does the work.
- Using a projected rent rather than the rent the property earns or comparable rentals support.
Frequently asked questions
Is a higher cap rate better?
More income for each dollar of price is better, all else equal, but all else is rarely equal. Higher cap rates usually come with more risk: older buildings, weaker areas, higher turnover or income that may not last. Compare a property's cap rate with similar rentals nearby, then find out why it is higher or lower before treating it as a bargain.
Does cap rate include the mortgage?
No. Cap rate uses net operating income, which is income minus operating expenses before any loan payment. That is deliberate: it measures the property, not the buyer's financing. To see the effect of the mortgage on your own money, use the cash-on-cash return, which subtracts the loan payments and divides by the cash you put in.
What is cap rate compression?
Cap rate compression is when cap rates fall across a market, usually because interest rates drop or buyers compete harder. Prices rise faster than income, so the same NOI buys less. The opposite, cap rate expansion, tends to follow rising rates. Either one changes what a property is worth even when its rent and expenses do not move at all.
Is cap rate the same as ROI?
No. Cap rate is a single year's NOI over the price, as if bought with cash. ROI is a broader idea, the total gain on what you invested, and can include cash flow, principal paydown, appreciation and the effect of the loan. A property with a modest cap rate can deliver a strong or weak ROI depending on its financing and how its value changes.
Do lenders use cap rate on a rental property loan?
Rarely for a house or small rental. DSCR lenders size the loan on the debt service coverage ratio, the rent divided by the monthly payment of principal, interest, taxes, insurance and dues, plus the appraised value from comparable sales. Commercial lenders on larger buildings do look at cap rates, through the appraisal's income approach.
Sources
General education, not financial, tax or legal advice. Figures are examples: rates, rules and programs change, and every lender sets its own. Last checked November 4, 2026.