Capitalization Rate (Cap Rate)
Cap rate is a rental property's net operating income (NOI) divided by its purchase price, expressed as a percentage. It measures the property's unlevered annual return and lets investors compare deals independent of financing.
Cap rate = NOI ÷ purchase price. NOI is gross rental income minus operating expenses (taxes, insurance, maintenance, management, vacancy allowance) — but not mortgage payments. Because financing is excluded, cap rate isolates how well the property itself performs.
Higher cap rates generally mean more income per dollar invested but often come with more risk or management burden; lower cap rates are typical of newer properties in premium areas. Compare cap rates within the same market and property class, not across them.
Worked example
A rental is bought for $240,000. It rents for $2,100/month ($25,200/year) and operating expenses run $7,200/year. NOI = $25,200 − $7,200 = $18,000. Cap rate = $18,000 ÷ $240,000 = 7.5%.
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