The cap rate for a rental property is its annual net operating income divided by its current market value, written as a percentage. A building that nets $50,000 a year and is worth $1,000,000 has a 5% cap rate. Across the country, multifamily properties have averaged around 5.7% heading into 2026, though individual deals run anywhere from under 4% to well above 10% depending on location, age, and risk.
The number is useful because it strips financing out of the picture. Two investors can look at the same building and disagree about the mortgage, the tax strategy, or the exit plan, but they can still agree on what the property earns relative to what it costs. That shared baseline is what makes cap rate the default shorthand in rental real estate.
The Formula
Cap Rate = (NOI ÷ Market Value) × 100
Take a fourplex that collects $72,000 a year in gross rent. Vacancy losses come to $2,500, and operating expenses run $29,500. That leaves net operating income of $40,000. The asking price is $500,000.
$40,000 ÷ $500,000 = 0.08, or an 8% cap rate.
The property returns 8 cents on every dollar of value per year, before any mortgage. Everything else about cap rate builds on this one calculation, so the two inputs deserve careful attention.
Building the NOI
Net operating income is what the property earns after normal operating costs. Start with gross potential rent, which is what you would collect if every unit stayed full and every tenant paid on time. Subtract a vacancy and collection loss estimate. Comparable properties in most markets lose 3% to 5% of gross rent this way, though the right figure depends on the neighborhood and the building’s own history. What remains is effective gross income.
From effective gross income, subtract the recurring costs of running the building:
- Property taxes, which effectively run from about 0.3% of assessed value in the lowest-tax states to over 2% in the highest, with most falling between 0.5% and 1.8%.
- Landlord insurance, typically $800 to $3,000 a year for a standard single-family rental and roughly 15% to 25% more than a comparable homeowners policy.
- Professional property management, generally 8% to 12% of collected rent.
- Routine maintenance and repairs: landscaping, plumbing calls, appliance work.
What’s left is NOI. Three things do not belong in this figure: mortgage payments, income taxes, and depreciation. Major capital projects like a roof replacement also stay out, because they are capital expenditures rather than operating costs. NOI is meant to represent the property’s earning power on its own, independent of how you finance it or how the IRS treats you.
Pinning Down Market Value
The denominator is what the property is worth today. You can use the actual purchase price if the sale is recent, a professional appraisal, or the sale prices of comparable nearby properties. Whichever method you pick, be careful with it. A 5% error on a $500,000 property shifts the cap rate by roughly half a percentage point, which is enough to change a decision.
Working the Formula in Reverse
Once you know the cap rate that prevails in a market, you can flip the equation to test an asking price:
Value = NOI ÷ Cap Rate
A building generating $60,000 in NOI in a market where comparable properties trade at 6% implies a value of $1,000,000. If the seller wants $1,200,000, the market rate doesn’t support the price. This reverse calculation is the backbone of commercial real estate appraisal, and it’s the fastest way to sanity-check what a seller is asking.
What Counts as a Good Number
There is no universal answer. Cap rate compresses risk and return into a single figure, and the right level depends on what you’re trying to accomplish.
- 4% to 5%: typical for newer buildings in high-demand cities. Low risk, stable tenants, thin margins that leave little room for surprises.
- 5% to 7%: the middle ground where a lot of investors work. Moderate risk in exchange for real cash flow, often in solid suburban markets.
- 8% and above: higher-risk properties in weaker markets, older buildings, or areas with volatile demand. The bigger number is compensation for the real chance that income drops or costs spike.
For context, multifamily cap rates nationally averaged about 5.7% in 2025 and held steady into 2026, with going-in cap rates across major metros closer to 4.75%. If someone offers you a “12% cap rate deal” in a market where everything else trades at 6%, that isn’t a bargain. It’s a signal that the market sees a risk the seller isn’t advertising.
How Property Class Shapes the Range
Investors sort buildings into classes by age, condition, and location, and cap rates track those classes closely.
Class A properties are the newest and best-located, with modern amenities and financially strong tenants. Cap rates usually run 4% to 5%. The yield is low because the risk of expensive repairs, long vacancies, or tenant defaults is low.
Class B buildings are older but functional, like a well-kept 1990s complex in a stable neighborhood that could use cosmetic updates. These trade between 5% and 7%, balancing cash flow against manageable risk.
Class C properties are typically 30 years or older, in less desirable locations with higher turnover. Cap rates commonly land between 7% and 10%. The higher return is compensation for buildings that tend to eat money through deferred maintenance, vacancies, and less stable tenancy.
Class D properties sit at the extreme: severely distressed buildings in struggling areas. Cap rates above 10% are common, but the number can mislead. A 12% cap rate means little when half the units are empty and the roof is failing. Most investors avoid this class unless they have renovation experience and enough capital to absorb losses during a turnaround.
What Moves Cap Rates
Cap rates shift with the broader economy and the local market.
Interest Rates
The 10-year Treasury yield sat around 4.1% in early 2026. That matters because investors compare it to cap rates when deciding whether rental property is worth the extra work. If a Treasury bond pays 4% with no landlord headaches, a 5% cap rate property offers only one point of risk premium for tenants, maintenance, and market exposure. When rates rise, buyers demand higher cap rates. When rates fall, cap rates tend to compress because more capital chases property deals.
Local Supply and Demand
Strong rental demand in a growing area pushes property values up faster than rents rise. NOI stays roughly the same while the denominator grows, so the percentage shrinks. This is cap rate compression. Areas with population loss or weakening job markets go the other direction, with buyers demanding higher cap rates as compensation for the real chance of vacant units or falling rents. It’s why two properties with identical NOI can trade at wildly different cap rates depending on which city they sit in.
Cap Rate vs. Cash-on-Cash Return
Cap rate assumes an all-cash purchase, which almost nobody does. Once a mortgage enters the picture, the more relevant metric is cash-on-cash return: annual pre-tax cash flow divided by cash invested.
On the earlier $500,000 fourplex with $40,000 NOI, putting $125,000 down and financing the rest with $24,000 in annual mortgage payments produces $16,000 of pre-tax cash flow. That’s a cash-on-cash return of 12.8%.
Leverage lifted the return from 8% to 12.8%, and it lifted the risk by the same mechanism. If NOI drops $10,000 through a long vacancy, the cash-on-cash return falls to 4.8% while the debt payment stays put. Cap rate tells you how the property performs. Cash-on-cash return tells you how the deal performs for you, given your financing.
What Cap Rate Won’t Tell You
The metric is useful because it’s simple, and that simplicity leaves several things out.
It’s a snapshot. Cap rate uses one year of income and today’s value. It says nothing about future rent growth, expense inflation, or how the neighborhood will evolve during your holding period. Internal rate of return handles those questions; cap rate can’t.
It ignores tax benefits. The IRS lets you depreciate the structure of a residential rental over 27.5 years, generating a paper loss that offsets taxable income even when cash flow is positive. Two properties with the same cap rate can produce very different after-tax returns depending on depreciable basis and the investor’s tax bracket.
It skips capital costs. NOI only includes recurring operating expenses. A $25,000 roof or $15,000 parking lot won’t appear in the calculation, because those get capitalized rather than expensed. A building that needs $50,000 in deferred maintenance can show the same cap rate as one that was just renovated, and the cash impact on the buyer is nothing alike. Always look behind the number at the property’s condition.
It assumes stable occupancy. The NOI used in a cap rate calculation typically reflects a reasonably full building running at expected income. A property that’s half-vacant during lease-up or losing tenants to a new competitor will produce an NOI that bears little resemblance to what the cap rate implies. Before trusting the number, verify whether the NOI came from actual trailing income or from a seller’s projection of what the building could earn once full.