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How to calculate cap rate on a rental property, with examples

By Spruce Sheets · Updated November 14, 2026 · 6 min read

Cap rate is one of the first ratios investors quote on a rental, and one of the easiest to misuse. It is a simple yield: how much the property earns in a year, before financing, as a percentage of its price. It is useful for comparing properties on equal footing. It is not a substitute for cash flow, cash-on-cash return or DSCR, because it does not know anything about your loan. This guide shows the formula, two worked examples, and the difference between a going-in cap rate and an exit cap rate.

General information, not investment, appraisal or tax advice. The examples are made up. A cap rate is only as good as the NOI and the value you put into it, and what counts as a reasonable cap rate is local.

The cap rate formula

Cap rate = annual net operating income ÷ property value

• Annual NOI is yearly effective rent minus operating expenses. Do not subtract the mortgage payment, and do not subtract depreciation. If you only have monthly figures, multiply a representative monthly NOI by 12.
• Property value is usually the purchase price when you are evaluating a deal (the going-in cap rate). Later, you can use an appraised or comparable-sales value to get a current or exit cap rate.

Because the loan is left out, two buyers who finance the same property differently will still compute the same cap rate. That is the point of the ratio: it describes the property, not the deal structure.

Worked example: two prices, the same NOI

A made-up rental produces $18,000 of annual NOI, or $1,500.00 a month, after a realistic vacancy allowance and operating expenses. You are looking at two asking prices.

	Property A	Property B
Annual NOI	$18,000	$18,000
Price	$300,000	$360,000
Cap rate	6.00%	5.00%

Property A yields 6.00% on the price before financing; Property B yields 5.00%. If the buildings, locations and risk were truly comparable, A is the cheaper property relative to its earnings. In the real world you would also ask why B costs more: a better block, a newer roof, lower expected capex, or simply a more optimistic seller.

Cap rate moves when either input moves. If Property A's NOI were $1,000 a year higher and the price stayed $300,000, the cap rate would be 6.33%. If the income stayed $18,000 and the value later rose to $330,000, the cap rate would fall to 5.45%. That second figure is an exit (or current) cap rate: same income, higher value, lower yield.

Cap rate is not cash-on-cash return

Now finance Property A. You put 25% down ($75,000), pay $5,000 in closing costs and $4,000 in initial repairs, and borrow $225,000 at 7.00% for 30 years. The monthly payment is $1,496.93, or $17,963.17 a year.

	Amount
Annual NOI	$18,000
Annual debt service	$17,963.17
Annual cash flow	$36.83
Cash invested	$84,000
Cash-on-cash return	0.04%
Cap rate (for comparison)	6.00%

The cap rate is still 6.00%. The cash-on-cash return is almost nothing, because nearly all of the NOI is going to the loan. The loan constant — annual debt service divided by the loan — is 7.98%, which is higher than the 6.00% cap rate. When you borrow at a constant above the cap rate, leverage works against cash flow. That is negative leverage, and cap rate alone will not warn you about it.

If you bought Property A for all cash, with the same $5,000 of closing costs and $4,000 of repairs, your cash in would be $309,000 and the $18,000 of NOI would be the cash flow. The cash-on-cash return would be 5.83%, close to the cap rate, with the gap explained by the extra cash you spent above the purchase price.

The lesson is not that leverage is always bad. It is that cap rate and cash-on-cash return answer different questions, and you need both. For the cash-on-cash formula in more detail, see cash-on-cash return: formula and example.

Going-in cap rate vs exit cap rate

• Going-in cap rate uses the NOI you expect in the first year (or a stabilized year) and the price you pay. It is the yield at purchase.
• Exit cap rate is the cap rate implied by a future sale: expected NOI in the year you sell, divided by the expected sale price. If buyers in the future pay a higher price for the same income, the exit cap rate is lower than the going-in rate.

People sometimes apply a "cap rate compression" story to justify a higher sale price later. That may or may not happen. A more conservative projection keeps the exit cap rate at or above the going-in rate, so you are not relying on future buyers to pay more for each dollar of NOI than you did.

What cap rate leaves out

Cap rate is a one-year snapshot of unlevered yield. It does not include:

• How you finance the property, or whether the loan will still work if rates rise.
• Principal paydown, which is part of your total return but not of NOI.
• Expected appreciation, or a future sale.
• Income taxes, including depreciation.
• One-off capital work that you have reserved for in capex but that may arrive in a lump.

It is also only as honest as the NOI. Using asking rent with no vacancy, skipping a capex reserve, or leaving out owner-paid utilities will inflate the cap rate. Two listings with "7% cap" are not comparable until you have rebuilt both NOIs the same way.

Is there a good cap rate?

No single number. A cap rate that looks high in one city can be normal in another, and a higher cap rate often comes with older buildings, weaker locations or more management. Use it to compare similar properties in the same market, and as a cross-check against cash flow and DSCR, not as a pass/fail rule.

The 1% rule (monthly rent at least 1% of the price) is an even rougher shortcut. It ignores expenses entirely. A property can pass the 1% rule and still have a weak cap rate if expenses are heavy, or fail it and still be fine if expenses are light. When you are past the first screening, replace shortcuts with NOI.

Doing it in a spreadsheet

Cap rate is a division, but the work is in the NOI. Put price, rent, vacancy and every operating expense in one place, calculate annual NOI, and divide. The free Spruce Sheets Rental Property Cash Flow Calculator does that alongside cash flow, cash-on-cash return and DSCR. The Rental Property Analysis Calculator compares up to five deals and includes a 10-year projection if you also want to look at an exit.

The examples are made up. This guide is not investment, appraisal or tax advice. Rebuild NOI from source documents before you rely on a listed cap rate.

Frequently asked questions

What is the formula for cap rate on a rental property?

Cap rate, or capitalization rate, is the property's annual net operating income divided by its price or current market value, expressed as a percentage. Financing is left out: the same property has the same cap rate whether you pay cash or borrow.

What is a good cap rate for a rental property?

There is no universal good cap rate. It varies by market, property type, condition and risk. A higher cap rate means a higher yield on the price, and often a higher perceived risk or a less expensive market. Compare a property with similar properties in the same area, rather than with a national rule of thumb.

Is cap rate the same as cash-on-cash return?

No. Cap rate ignores the loan and compares NOI with the property's price. Cash-on-cash return compares annual cash flow after the loan payment with the cash you actually invested. Leverage can make cash-on-cash higher or lower than the cap rate.

Keep reading

• How to calculate rental property cash flow, step by step
• Cash-on-cash return on a rental: formula, example and what it leaves out
• How to calculate DSCR for a rental loan, with a worked example