Cap Rate Explained: What It Actually Tells You About a Rental Property

Cap rate, short for capitalization rate, answers a specific question: if you bought this property in all cash, what percentage return would the income alone give you in a year? It ignores financing entirely. That's the point. It lets you compare two properties on the strength of the deal itself, before debt changes the picture.

The formula

Cap rate = Net Operating Income divided by purchase price (or current market value). Net operating income, or NOI, is rental income minus operating expenses, before any mortgage payment. It's the same NOI figure used in a DSCR calculation, just compared against price instead of debt.

A worked example

Say a duplex is listed at $300,000. It brings in $36,000 a year in rent. Taxes, insurance, maintenance, management, and a vacancy reserve add up to $12,000 a year, leaving $24,000 in NOI.

$24,000 divided by $300,000 comes out to 0.08, or an 8% cap rate. That's the return you'd get from the property's income alone, no mortgage involved.

What counts as a good cap rate

• 4% to 6%: common in expensive, low-risk markets. Coastal metros, strong school districts, properties where buyers are paying for appreciation and stability more than yield.
• 7% to 10%: the range most cash-flow-focused investors target. Solid middle-market properties in growing but not overheated areas.
• 10%+: usually signals higher risk. Rougher neighborhoods, older buildings with real deferred maintenance, or a market where growth has stalled. Not automatically bad, but it deserves a harder look at why the number is that high.

There's no universal "good" cap rate. An 8% cap rate is strong in a market where everything else trades at 5%, and mediocre in a market where 10% is normal. Compare a property to others in the same city and property type, not to a number from a national article.

What cap rate can't tell you

Cap rate says nothing about financing. Two properties with an identical 8% cap rate can perform completely differently once one is bought in cash and the other with a mortgage at today's rates. That's what cash-on-cash return is for, and it's worth running both before you commit to a deal.

Run it on your own numbers

RentLedger's calculator runs cap rate, DSCR, and cash-on-cash together on the same deal, using your actual rent roll and expenses instead of a rough estimate.