- What is a cap rate?
- Capitalization rate = Net Operating Income ÷ property value, expressed as a percentage. It's the unleveraged annual return — what the property would yield if you paid all cash, before any mortgage. Investors use it to compare rental properties the same way stock investors compare P/E ratios: it normalizes price across deals of different sizes.
- What's a good cap rate?
- Depends on the market. In stabilized US residential, 5-8% is the typical band — Class A multifamily in core metros often trades at 4-5%, suburban single-family in secondary markets at 6-9%, and value-add or tertiary markets at 9%+. Below 4% usually means the buyer is paying for appreciation potential, not income. Above 10% usually flags real risk (distressed property, declining area, or rent assumptions that won't hold).
- Why doesn't cap rate include the mortgage?
- On purpose. Cap rate measures the property; cash-on-cash return measures your specific deal. The same property has one cap rate but a different cash-on-cash return for every buyer (depending on down payment, loan terms, interest rate). Stripping out financing lets you compare properties — which is the whole point. To see your actual leveraged return, run cash-on-cash separately.
- What's the difference between cap rate and ROI?
- Cap rate is income yield only (NOI ÷ price). ROI typically also includes appreciation, principal paydown from a mortgage, and tax benefits — it's the total return on the cash you actually invested. A property with a 5% cap rate might deliver 12% ROI after factoring in appreciation and leverage. Cap rate is one input into ROI, not a substitute.
- What counts as an operating expense?
- Costs to operate the property, debt-free: property taxes, insurance, maintenance and repairs, capex reserve (a budget for roof, HVAC, water heater replacement over time), property management fees, landlord-paid utilities, HOA dues, accounting, and turnover/vacancy costs. NOT included: mortgage principal and interest, depreciation, income taxes, capital improvements that add square footage, your personal labor.
- Should I use the purchase price or current market value?
- Both are legitimate, and they answer different questions. Cap rate at purchase price tells you what return you're locking in if you buy today. Cap rate at current market value tells you what return the property is earning right now (regardless of what you paid years ago). Investors evaluating a buy decision use purchase price. Owners deciding whether to sell or refinance use market value.
- Why is my cap rate negative?
- NOI is negative — your operating expenses (plus vacancy assumption) exceed your gross rent. The property loses money before any mortgage payment, which means it can't service a loan or generate cash for the owner. Check the expense inputs: maintenance and vacancy assumptions can be aggressive. If the math is real, the rent is too low or the expenses too high for the property to work as a rental at the current value.
- Does cap rate predict appreciation?
- Inversely, roughly. Low-cap-rate markets (San Francisco, Manhattan, Vancouver) historically appreciated faster than high-cap-rate markets — investors bid the income yield down because they expect price growth to make up for it. High-cap-rate markets (Cleveland, Memphis, Birmingham) typically have flatter price trajectories but throw off more cash. Neither is universally better; they're different strategies.
