How to Calculate Cap Rate on a Rental Property (With Examples)
RealtyDealScout Team
August 12, 2026
Cap rate — short for capitalization rate — is the single most-used shorthand for comparing rental properties. It answers one question: if you paid cash for this property, what percentage return would the property itself generate every year? No mortgage, no leverage, just the property's ability to produce income relative to its price.
The Cap Rate Formula
Cap Rate = (Net Operating Income ÷ Purchase Price) × 100
NOI is annual — always divide a full year of income, not a monthly figure.
The purchase price part is simple. Net Operating Income (NOI) is where most people get it wrong, so it's worth being precise.
What Counts as Net Operating Income (NOI)?
NOI is annual rental income minus operating expenses — and critically, it does not include your mortgage payment. Cap rate is meant to measure the property, not your financing, so debt service is deliberately left out. The expenses that *do* count:
- Property taxes
- Insurance
- Vacancy allowance (a reserve for months the unit sits empty)
- Maintenance and repairs
- CapEx reserve (roof, HVAC, and other big-ticket replacements)
- Property management fees (even if you self-manage — this is what it would cost)
- HOA dues, if applicable
Worked Example
Here's a property we'll use throughout this series — a $200,000 single-family rental rented at $2,400/month, with typical operating assumptions (5% each for vacancy, maintenance, and CapEx; 10% property management; 2.88% property tax rate; $1,200/year insurance):
| Line item | Annual amount |
|---|---|
| Gross rental income | $28,800 |
| − Vacancy (5%) | $1,440 |
| − Maintenance (5%) | $1,440 |
| − CapEx reserve (5%) | $1,440 |
| − Property management (10%) | $2,880 |
| − Property taxes | $5,760 |
| − Insurance | $1,200 |
| = Net Operating Income (NOI) | $14,640 |
7.3%
$14,640 NOI ÷ $200,000 purchase price × 100
Skip the spreadsheet
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What's a Good Cap Rate in 2026?
There's no single universal cutoff — a 5% cap rate might be excellent in a low-crime, appreciating suburb and mediocre in a cash-flow-focused Midwest market. That said, most buy-and-hold investors use bands like these as a starting screen:
| Cap rate | General read |
|---|---|
| 8%+ | Strong — common in cash-flow-focused secondary/tertiary markets |
| 5% – 8% | Fair — typical for many stable, appreciating markets |
| Below 5% | Weak on a pure income basis — usually means you’re paying for appreciation, not cash flow |
These are screening bands, not laws
A 4% cap rate property in a fast-appreciating market can easily outperform an 8% cap rate property in a declining one over a 10-year hold. Cap rate is a fast filter for comparing similar properties in similar markets — not a complete investment thesis on its own.
What Cap Rate Doesn’t Tell You
Because cap rate ignores financing entirely, it can't tell you what your actual cash flow will look like after a mortgage payment — that's what cash-on-cash return and DSCR are for. It also doesn't account for appreciation, tax benefits, or principal paydown. Think of cap rate as the first filter, not the final answer.
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