Capitalization rate — "cap rate" — is the first metric a rental investor looks at when sizing up a deal. It compresses a property's annual income performance into one percentage that you can compare across deals, neighborhoods, and asset classes. The math is one short formula. The discipline is being honest about what goes into it.

The cap rate formula

Cap rate = Net Operating Income (NOI) ÷ Property value × 100

If a duplex generates $24,000 in NOI on a $400,000 purchase price, the cap rate is 6.0%. That's it. The simplicity is what makes it useful — and what makes it easy to misuse, because almost all the variance happens inside NOI.

What counts as NOI (and what doesn't)

Net Operating Income is the property's annual income after operating expenses, but before debt service and income tax. The lines that belong in NOI:

  • Gross rental income — what you actually expect to collect, not the asking rent on a listing
  • Less vacancy — typically 5%–8% of gross rent in stable markets, more in transient ones
  • Less operating expenses — property tax, insurance, property management (8%–10%), repairs, maintenance, HOA, utilities the owner pays, landscaping, capex reserves

The lines that don't belong: mortgage payments, depreciation, your own labor, and one-time rehab costs. Cap rate is supposed to describe the property's earning power independent of how you finance it — so leverage stays out of the formula.

The most common mistake: forgetting capex reserves

Roofs, HVAC, water heaters, and exterior paint don't fail every year, but they fail eventually. A property without a capex reserve in NOI looks artificially profitable. The rule of thumb is to set aside 5%–10% of gross rent for long-term repairs. Skipping this is how new investors end up with a 7% cap rate that turns into a 4% cap rate the year the roof goes.

What's a "good" cap rate in 2026?

Cap rates move with interest rates and risk perception. As of early 2026, typical ranges:

  • Class A multifamily, top-tier metros (Austin, Seattle, Boston): 4.5%–5.5%
  • Class B suburban multifamily: 5.5%–7.0%
  • Single-family rentals, growth markets: 5.5%–6.5%
  • Class C value-add: 7.5%–9.0% — but with elevated capex risk
  • Tertiary markets, small towns: 8%–10%+

A higher cap rate is not automatically better. It usually reflects more risk: weaker tenant pool, deferred maintenance, declining population, or a softer rental market. A 9% cap in a town losing population is often worse than a 5.5% cap in one growing 2% a year.

Cap rate vs cash-on-cash return

Investors confuse these all the time. Cap rate measures the property; cash-on-cash measures your investment. If you put 25% down on that $400,000 duplex, your cash-on-cash return depends on financing terms — which the cap rate ignores entirely. Use cap rate to compare properties; use cash-on-cash to evaluate your own deal.

The 1% rule and how cap rate replaces it

You'll see the "1% rule" — monthly rent ≥ 1% of price — quoted as a quick screen. It's a useful first filter in cheap markets, but it's a coarser version of cap rate. The 1% rule implies roughly an 8% gross yield, which after 40%–50% expense ratio puts you near a 5% cap. In expensive coastal markets the 1% rule has been dead for a decade; cap rate scales gracefully across price ranges.

Try the numbers

Our cap rate calculator takes purchase price, gross rent, vacancy, and operating expenses, and gives you NOI and cap rate side by side — so you can sanity-check listings before scheduling showings.