Cap Rate Calculator: How to Evaluate Rental Properties

I Almost Bought a Terrible Rental Property

About two years ago, I was looking at a duplex listed for 285,000. The seller's agent kept saying it was a "great investment" and threw out a number — something like 12,000 a year in rental income — and honestly, I almost wrote the offer that afternoon. The price seemed reasonable, the neighborhood was decent, and I figured the math would work itself out.

It didn't.

When I actually sat down and ran the cap rate, the property was sitting at about 4.2%. Which, for a duplex in a secondary market with deferred maintenance and a roof that looked like it had survived three wars, was.. not great. I mean, I could've parked that money in a high-yield savings account and done almost as well without ever worrying about a tenant calling me at 2 AM about a leaky faucet.

So that's what cap rate does for you — it's a quick gut-check number that tells you whether a rental property is actually worth your attention or if you're about to overpay for someone else's headache. And once you know how to calculate it (which takes about 30 seconds), you'll never look at a listing the same way again.

The Cap Rate Formula — It's Simpler Than You Think

Cap rate stands for "capitalization rate," which sounds fancy but is basically just a ratio. It tells you what percentage of the property's value you'd earn back in net operating income each year. That's it. One ratio, one percentage, one quick answer.

💡 THE FORMULA

Cap Rate = (Net Operating Income ÷ Property Value) × 100

Net Operating Income (NOI) = Annual rental income minus operating expenses (but NOT mortgage payments)
Property Value = Purchase price or current market value

The part that trips people up is NOI. Your net operating income is your gross rental income minus all the operating costs — property taxes, insurance, maintenance, property management fees, vacancy allowance, that kind of thing. But here's the key: you do NOT subtract your mortgage payment. Cap rate is supposed to measure the property's performance independent of how you financed it. Two investors can buy the same building with totally different loan terms, and the cap rate stays the same for both of them.

Let me walk through a real example.

Say you're looking at a fourplex listed at 400,000. Each unit rents for 1,100 a month, so your gross annual income is 52,800. Now subtract the operating expenses:

So your NOI is 52,800 minus 17,264, which gives you 35,536. Divide that by the purchase price of 400,000, multiply by 100, and you get a cap rate of about 8.9%.

That's a solid number. Not spectacular, not terrible — right in the sweet spot for a lot of rental markets. But whether 8.9% is "good" depends entirely on where the property is and what you're comparing it to, which brings me to the next part.

What's Actually a "Good" Cap Rate?

This is the question everyone asks and nobody gives a straight answer to. So I'll try.

A cap rate between 5% and 10% is where most residential rental properties land. Below 5%, you're usually looking at a premium market — think downtown condos in major cities where appreciation is the play, not cash flow. Above 10%, you're either in a rougher neighborhood, a smaller market, or there's some hidden risk the numbers aren't showing you (like a tenant who hasn't paid in six months, or a foundation that's slowly cracking).

But here's something I learned the hard way: cap rate alone doesn't tell you everything. It ignores financing completely (remember, no mortgage in the calculation), so a property with an 8% cap rate might still have negative cash flow if you put very little down and your interest rate is high. That's why I always run the rental property calculator alongside the cap rate — it factors in your actual loan terms and gives you a much fuller picture.

And cap rate doesn't account for appreciation either. A 4% cap rate in a market where values are climbing 6-7% a year might actually be a better total return than a 9% cap rate in a flat market. Context matters a lot.

Running the Numbers on Your Deal

If you're evaluating a property this week (and I'm guessing you are, since you're reading this), here's what I'd actually do step by step:

Step 1: Get the gross annual rent. If the property is already occupied, ask for a rent roll. If it's vacant, check comparable rents in the area using Zillow, Rentometer, or whatever you trust. Don't use the seller's "projected" rents — those are almost always inflated. I've seen agents project rents 15-20% above market and just hope nobody checks.

Step 2: Estimate operating expenses. A common shortcut is the 50% rule — assume about half your gross rent goes to expenses. It's rough, but it gets you in the ballpark for a quick screening. For a more precise number, you'll want to dig into actual tax records, get insurance quotes, and budget for maintenance (I usually use 1-2% of the property value per year for maintenance on older buildings).

Step 3: Calculate NOI. Gross rent minus expenses. Simple subtraction.

Step 4: Divide by the purchase price. That's your cap rate.

Step 5: Compare. Look at 3-5 similar properties in the same area and run cap rates on all of them. One number in isolation means almost nothing — it's the comparison that tells you whether you're getting a deal or getting taken.

You can also use the cap rate calculator to skip the manual math entirely. Just plug in your numbers and it spits out the answer. I use it constantly when I'm scrolling through listings because it saves me from doing the same division forty times in a row.

Once you've got your cap rate, I'd also recommend running the cash-on-cash return calculator to see what your actual return looks like based on your down payment and loan terms. And if you're trying to figure out what offer price would hit your target cap rate, you can reverse-engineer it — just take your NOI and divide by your desired cap rate as a decimal. So if your NOI is 35,000 and you want an 8% cap rate, your max purchase price is 35,000 ÷ 0.08 = 437,500.

That reverse calculation has saved me from overpaying more than once.

A Few More Tools Worth Running

Cap rate is a starting point, not the finish line. For a complete analysis, I'd also look at your return on investment over a 5-10 year hold period, your mortgage payment to make sure the cash flow actually works month to month, and your debt service coverage ratio if you're going through a commercial lender (they'll almost certainly ask for it).

And if you're comparing a rental property against other investment options, the investment calculator can help you see how the same money would perform in, say, an index fund over the same time horizon. Sometimes the boring option wins!

Oh, and don't forget about the NOI calculator if you want to be really precise about your operating expenses before plugging them into the cap rate formula. Getting NOI right is honestly the hardest part of this whole exercise — the cap rate math itself is trivial.

Does cap rate include mortgage payments?

No, and this is the most common mistake I see. Cap rate uses Net Operating Income, which excludes debt service (your mortgage). It's designed to evaluate the property itself, regardless of how it's financed. If you want to factor in your loan, look at cash-on-cash return instead.

Can I use cap rate for single-family rentals?

You can, but take it with a grain of salt. Cap rate works best for multifamily and commercial properties where cash flow is the primary goal. Single-family homes in appreciating markets often have lower cap rates (3-5%) because buyers are banking on price growth, not just rental income. It's still a useful screening tool — just not the only number you should look at.

What if the seller's listed cap rate seems too high?

Be skeptical. Sellers (and their agents) love to inflate cap rates by understating expenses or overstating rents. Always recalculate using your own expense estimates and verified market rents. I've seen listed cap rates of 10-11% that dropped to 6-7% once I plugged in realistic numbers. Trust but verify — actually, just verify.