What is a cap rate?
The capitalization rate is the return a property would earn in one year if you bought it with all cash. Because it ignores financing, it lets you compare buildings on equal terms no matter how each buyer pays for them.
What goes into NOI?
Net operating income is all income after vacancy, minus the costs of running the property: property taxes, insurance, utilities the owner pays, repairs, management and similar items. It does not include mortgage payments, depreciation, capital improvements or income tax.
Using cap rate to set your offer
Rearrange the formula and cap rate becomes a valuation tool: value = NOI ÷ cap rate. If similar buildings in the area trade at a 7.5% cap rate and this one produces $100,000 of NOI, it is worth roughly $1.33 million. Paying more means accepting a lower return than the market. Use the target cap rate field above to see the maximum price for your deal.
Verify the seller's NOI
Listings often show a "pro forma" cap rate built on ideal rents and understated expenses. Ask for the trailing 12-month profit and loss, rent roll and tax bill, then rebuild NOI yourself with realistic vacancy and management costs.
Frequently asked questions
What is a good cap rate?
It depends on the market and property type. Class A buildings in large coastal cities often trade at 4–5.5%, while older properties in smaller markets can trade at 8–10% or more. A higher cap rate means more income per dollar, but usually more risk.
Does cap rate include the mortgage?
No. Cap rate is calculated before financing. To include your loan, use cash on cash return.
What is the gross rent multiplier?
GRM is price divided by gross annual rent. It is a rougher screen than cap rate because it ignores expenses, but it is useful for comparing similar properties quickly.
Why do cap rates change when interest rates rise?
Buyers compare property returns with borrowing costs and bond yields. When rates rise, buyers demand higher cap rates, which pushes prices down if NOI stays the same.