How to Calculate Cap Rate: Formula, Examples & 2026 Benchmarks
Cap rate is the single most useful number for screening investment properties — but most investors calculate it wrong. This guide breaks down the exact formula, what counts as NOI, worked examples for Memphis and Cleveland, and the five calculation mistakes that can turn a profitable deal into a money pit.
Cap rate (capitalization rate) = Net Operating Income (NOI) ÷ Property Value × 100. NOI is gross rental income minus all operating expenses (property taxes, insurance, management, maintenance, vacancy) — excluding mortgage payments and capital expenditures. A $250,000 property with $18,000 annual NOI has a cap rate of 7.2%.
What Is Cap Rate?
Cap rate, short for capitalization rate, is the ratio of a property's annual net operating income to its current market value or purchase price. In plain English: cap rate tells you your annual return if you bought the property entirely with cash.
It strips away financing, taxes, and personal financial situations so you can compare properties on equal footing — whether it's a $200,000 duplex in Memphis or a $2 million apartment complex in Dallas. That's what makes it the go-to screening metric for real estate investors, commercial appraisers, and institutional buyers.
Cap rate alone doesn't tell you whether a deal is good or bad. It tells you how efficiently the property converts its value into income — and gives you a standardized number to compare against similar properties in the same market.
The Cap Rate Formula Explained
Cap Rate = Net Operating Income (NOI) ÷ Property Value × 100
Example: $18,000 NOI ÷ $250,000 value × 100 = 7.2%
What Is Net Operating Income (NOI)?
NOI is the money your property generates after operating expenses, before any debt payments. It is not your cash flow. It is not your taxable income. It is the property's raw earning power as a standalone asset.
NOI = Gross Rental Income + Other Income − Operating Expenses
Operating Expenses — What's Included
- Property taxes
- Property insurance (landlord/hazard policy)
- Property management fees (typically 8–12% of rent)
- Routine maintenance and repairs
- Landlord-paid utilities (water, trash, common area electric)
- Landscaping, snow removal, pest control
- Vacancy allowance (typically 5–10% of gross rent)
Operating Expenses — What's Excluded
- Mortgage principal and interest (debt service)
- Income taxes
- Depreciation
- Capital expenditures (roof replacement, HVAC, major renovations)
Purchase Price or Current Market Value?
You can use either, but current market value is the professional standard. Here's why: if you bought a property for $300,000 five years ago and it's now worth $500,000, using your original price gives a misleadingly high cap rate that doesn't reflect today's reality. Current market value tells you what your investment could earn if you sold and reinvested — the true opportunity cost of keeping the property.
Worked Example 1: Single-Family Rental in Memphis, TN
Memphis is consistently one of the highest-yielding rental markets in the US. Here's a realistic 2026 scenario:
| Item | Amount |
|---|---|
| Purchase Price (current market value) | $250,000 |
| Monthly Rent | $2,000 |
| Gross Annual Rent | $24,000 |
| Annual Operating Expenses | $6,000 |
| Net Operating Income (NOI) | $18,000 |
- Calculate Gross Annual Income$2,000/month × 12 = $24,000/year
- Subtract Operating Expenses$24,000 − $6,000 = $18,000 NOI
- Apply the Cap Rate Formula$18,000 ÷ $250,000 × 100 = 7.2% cap rate
A 7.2% cap rate means if you paid $250,000 all-cash for this Memphis property, you would earn a 7.2% annual return purely from income — before appreciation, tax benefits, or any effect of financing leverage.
Worked Example 2: Multi-Family Property in Cleveland, OH
Cleveland consistently ranks as one of the highest-yielding major markets in the US, with cap rates significantly above national averages:
| Item | Amount |
|---|---|
| Current Market Value | $1,200,000 |
| Annual Rental Income | $144,000 |
| Annual Operating Expenses | $43,200 |
| Net Operating Income (NOI) | $100,800 |
| Cap Rate | 8.4% |
$100,800 ÷ $1,200,000 × 100 = 8.4% cap rate
This Cleveland multi-family has a higher cap rate than the Memphis single-family home — but that doesn't automatically make it the better deal. Higher cap rates typically signal higher perceived risk: older buildings, less stable tenant bases, slower appreciation markets. The Cleveland property requires more active management and carries more operational complexity. A higher cap rate is compensation for accepting that added complexity and risk.
What Is a Good Cap Rate in 2026?
There's no universal answer. A "good" cap rate depends on property type, location, asset class, and your personal risk tolerance. Here's what the data shows across US markets in 2026:
| Property Type | Cap Rate Range | Risk Level |
|---|---|---|
| Class A Multifamily — major cities | 4.5% – 5.5% | Low |
| Class B Multifamily — secondary markets | 5.5% – 6.5% | Medium |
| Class C Multifamily — tertiary markets | 6.5% – 8.0% | Higher |
| Single-Family Rentals | 5.0% – 8.0% | Medium |
| Commercial Retail | 6.0% – 9.0% | Medium-High |
| Industrial / Logistics | 5.0% – 7.5% | Low-Medium |
| Office Properties | ~7.7% | High (post-COVID vacancy risk) |
According to CBRE's U.S. Cap Rate Survey, multifamily properties averaged a 5.6% cap rate in Q1 2026 — holding steady for seven consecutive quarters. This reflects a market stabilizing after the rate shock of 2022–2024.
The Risk-Return Tradeoff
- Lower cap rates (4%–5.5%) — Safer, in-demand locations with stable tenants. New construction in Austin, Denver, or Miami. Lower current income, but stronger appreciation and liquidity.
- Higher cap rates (7%–10%+) — More risk. Often tied to older buildings, operational complexity, or weaker demand markets. Bigger cash flow potential for hands-on investors willing to accept volatility.
Cap Rate vs. Cash-on-Cash Return
These two metrics are frequently confused — but they measure very different things. Smart investors use both, at different stages of the analysis.
| Feature | Cap Rate | Cash-on-Cash Return |
|---|---|---|
| Formula | NOI ÷ Property Value | Annual Cash Flow ÷ Cash Invested |
| Includes financing? | ❌ No | ✅ Yes |
| Measures | Property's unlevered return | Your actual levered return |
| Best used for | Screening & comparing properties | Evaluating a specific financed deal |
| Typical "good" range | 5% – 10% (market-dependent) | 8% – 12%+ (investor-dependent) |
When to use cap rate: You're browsing listings and want to quickly rank 10 properties in the same market. Cap rate neutralizes financing differences and lets you compare on equal footing.
When to use cash-on-cash: You've narrowed to one property and need to know if your specific down payment, loan rate, and cash reserves produce the return you need after debt service.
Critical example: A property with an 8% cap rate could produce negative cash-on-cash return if you're financing at 7.5% interest with only 10% down. The cap rate looks strong, but your actual cash yield after mortgage payments is terrible. This is why cap rate alone never tells the full story. Use the Cash-on-Cash Return Calculator to model the full picture.
5 Cap Rate Calculation Mistakes That Destroy Returns
1. Including Mortgage Payments in NOI
The single most common error. Mortgage principal and interest are not operating expenses. Cap rate is designed to measure the property independent of how you finance it. Including your mortgage payment produces a number that's meaningless for comparison purposes — and almost always makes the deal look worse than it actually is.
2. Using Gross Rent Instead of NOI
A seller lists a property renting for $3,000/month. You calculate $36,000 ÷ $400,000 = 9% cap rate. But the property carries $12,000 in annual operating expenses. The real NOI is $24,000, producing a 6% cap rate. That 3% difference at $400,000 represents $12,000 in annual income you thought you were getting — but aren't. Always verify actual operating expenses before calculating NOI.
3. Ignoring Realistic Vacancy
Sellers present properties at 100% occupancy. Real markets average 5–10% annual vacancy. A property that sits empty for three months between tenants loses 25% of one quarter's income. Build in a vacancy allowance appropriate for your market and asset class — Class A typically 3–5%, Class C potentially 10–15%.
4. Using Outdated Purchase Price
Cap rate changes even when NOI stays constant, because property values fluctuate. If your market appreciated 25% over three years but rents only grew 8%, your cap rate compressed significantly — the property became less efficient at generating income relative to its current value. Recalculate using current market value annually.
5. Comparing Cap Rates Across Different Asset Classes
A 6% cap rate on a Class A apartment in Nashville is not comparable to a 6% cap rate on a 1980s strip mall in a rural Ohio county. Different property types, tenant bases, and markets carry fundamentally different risk profiles. Only compare cap rates within the same asset class and market tier.
2026 US Cap Rate Benchmarks by City
Here's where cap rates stand in major US markets as of mid-2026, based on CBRE market survey data and real estate transaction records:
| City / Market | Property Type | Typical Cap Rate |
|---|---|---|
| New York, NY | Class A Multifamily | 4.0% – 5.0% |
| San Francisco, CA | Class A Multifamily | 4.0% – 5.0% |
| Los Angeles, CA | Class A Multifamily | 4.0% – 5.0% |
| Austin, TX | Class A/B Multifamily | 4.5% – 5.5% |
| Dallas, TX | Class B Multifamily | 5.0% – 6.0% |
| Denver, CO | Class B Multifamily | 5.0% – 6.0% |
| Phoenix, AZ | Class B Multifamily | 5.0% – 6.5% |
| Atlanta, GA | Class B/C Multifamily | 5.5% – 6.5% |
| Cincinnati, OH | Class B/C Multifamily | 7.0% – 9.0% |
| Memphis, TN | Class C Multifamily | 7.5% – 9.0% |
| Cleveland, OH | Class C Multifamily | 8.0% – 10.0% |
| National Average | All Multifamily | ~5.6% – 6.5% |
Gateway markets (New York, LA, San Francisco) command lower cap rates because investors pay a premium for stability, liquidity, and long-term appreciation. Tertiary markets like Cleveland and Memphis offer higher cap rates to compensate for smaller buyer pools, older housing stock, and slower appreciation. Neither is inherently better — they represent different risk-return positions on the same spectrum.
Using Cap Rate for Property Valuation
Cap rate isn't just a screening tool — flip the formula and you can estimate what a property should be worth based on its income:
Property Value = NOI ÷ Cap Rate
Example: $35,000 NOI ÷ 0.07 (7% market cap rate) = $500,000
If similar properties in your target neighborhood trade at 7% cap rates and the property you're evaluating generates $35,000 in NOI, the implied market value is $500,000. This technique — called direct capitalization — is a standard method commercial appraisers use to value income-producing properties. It's also used by buyers to identify whether an asking price is justified by the income the property actually generates.
If the seller is asking $450,000 and market cap rates suggest $500,000 value, you may have found a below-market deal. If they're asking $575,000, you're paying above what the income supports at current market rates.
Calculate Cap Rate Instantly — Free
Run the numbers on any property with our free real estate calculators. No signup required.
Frequently Asked Questions
Disclaimer & Sources
This article is for informational and educational purposes only and does not constitute investment advice. Real estate investing involves risk and individual results vary. Always consult a qualified real estate professional, financial advisor, or CPA before making investment decisions.
Sources: CBRE U.S. Cap Rate Survey Q1 2026; National Association of Realtors Commercial Real Estate Outlook; Federal Reserve monetary policy data; AmericaCalculator.com internal market research. Cap rate ranges reflect mid-2026 transaction data and may change as market conditions evolve.