A cap rate is a rate that helps real estate investors evaluate an investment property. Our free cap rate calculator generates a property’s net operating income and cap rate based on inputs including property value, gross income and operating expenses. Investors can then decide whether the property is a good value.
Capitalization Rate Calculator Rule of Thumb
Here are some rules of thumb around cap rate for real estate investments:
- Good cap rate: Typically 4% – 10%+
- Bad cap rate: Generally anything less than 4%
- Cap rate time frame: It shows you the rate of return over a 1-year period
Keep in mind that cap rates vary based on the type of property, location and how the cap rate is calculated. To compare and contrast cap rates between properties accurately, they need to be in similar locations and the same type of property, for example, duplex or commercial property.
How the Cap Rate Calculator Works
The capitalization rate calculator gives you the property’s cap rate by dividing the net operating income (NOI) by the property value and multiplying that number by 100. To figure out the NOI, you multiply your gross rental income by your occupancy rate and then subtract operating expenses from your gross rental income.
Keep in mind that all of your calculations should be figured out on a yearly basis because the cap rate is calculated over the course of a year. If you know your monthly operating expenses, multiply that number by 12 to get your yearly operating expenses. You figure out the net operating income by taking your gross rental income and multiplying it by your occupancy rate and then subtracting all of your operating expenses.
Buy and hold investors typically consider rental property operating expenses to be all expenses that help keep the property up and running. These operating expenses include property taxes, insurance, management fees, maintenance, repairs and miscellaneous expenses. They do not include your investment property loan payments.
Cap Rate Formula
The cap rate formula is NOI / property value x 100.
Let’s take a look at a quick example of how to calculate NOI. Your gross rental income is $60,000, your occupancy rate is 85 percent and your operating expenses are $15,000.
$60,000 x 85% = $51,000
$51,000 – $15,000 = $36,000 NOI
Then to figure out your cap rate, you divide the NOI by the property value and multiply by 100.
$36,000 ÷ $400,000 = 0.09 x 100 = 9% cap rate
Some investors use different variations of the cap rate formula, but we find it most accurate if we incorporated the occupancy rate. From the above calculations, you can see just how much time the capitalization rate calculator will save you.
Cap Rate Calculator Inputs
Our cap rate calculator asks you to input certain things so it can calculate your NOI and cap rate based on the numbers you input. You need to input your property value, occupancy rate, gross rental income and so on. Keep in mind that cap rate is calculated over one year, so all inputs, except for property value, should be entered as the yearly number.
Cap rate calculator inputs include:
Property value is the first input on our cap rate calculator. Remember that property value is not the same as purchase price. Property value is the current fair market value (FMV) of the property. If you’re unsure of what your property is currently worth, you can find your current property value by asking a real estate agent or using the Zestimate tool on Zillow.
Gross Rental Income
Gross rental income should include more than just your rental income. It includes all income generated from the property. Your gross rental income is usually calculated monthly so multiply that monthly number by 12 to get the yearly number. This is done because the cap rate formula is based on yearly numbers.
Things included in your gross rental income are:
- Rental income from tenants
- Parking income
- Income from laundry facilities
- Vending income
- Any additional income the property generates
Your occupancy rate is the percentage of the units in your property that are rented at any given time. A typical occupancy rate is 90 to 95% or higher. The occupancy rate should be used on properties with two or more units. To calculate the occupancy rate, divide the number of rented units by the number of total units and multiply by 100.
Here’s an example of how to calculate occupancy rate. Total units: 10, Rented units: 7
Your occupancy rate would be 7 / 10 x 100 = 70%
Operating expenses on an investment property are any expenses associated with that property to keep it up and running. These include things like taxes, insurance and management fees. However, they don’t include your mortgage payments.
Typical investment property operating expenses include:
- Property taxes: These are assessed by a governing authority in the area the property is located and vary based on location, property value and size
- Property insurance: Rental property insurance helps protect your property from loss of income, damage and perils like weather-related damage; the average policy on a $200,000 rental property costs $1,473 to $1,596 per year
- Property management fees: These fees vary from 8 percent of gross collected monthly rent for an investment property to more than 25 percent of gross rent for a vacation rental property
- Maintenance and repairs: These include things to keep the property maintained like pest control, painting and lawn care as well as any necessary repairs; expect to pay about 1 percent of the property value per year on maintenance
- Miscellaneous expenses: These can include things like accounting and legal fees and common area utilities; it’s a good idea to have some extra reserves saved for them
When you add up all of the above expenses, you get your total operating expenses. This is important because your total operating expenses are needed to help you calculate your net operating income which is part of the cap rate formula.
Cap Rate Calculator Outputs
After you have put all of your inputs into our free cap rate calculator, it will calculate the numbers for you and give you your net operating income and your cap rate. You don’t need to worry about the calculations, but if you’re curious, we will give you the cap rate formula.
Cap Rate Formula = NOI / Property Value x 100
Net Operating Income
As we mentioned above, your NOI is calculated by multiplying your gross rental income by your occupancy rate. Then you subtract your total operating expenses from that number. You are left with your net operating income which is one of the cap rate calculator outputs and a component of the cap rate formula.
Cap rate is another output that our cap rate calculator gives you after you put in your inputs such as property value and gross rental income. The cap rate formula that the cap rate calculator uses is the property’s net operating income divided by the property value. That number is then multiplied by 100 and is given as a percentage. It’s used as a tool by investors for evaluating investment properties based on their value and NOI.
When to Use a Cap Rate to Judge Investment Property Potential
A cap rate is important to use when evaluating both commercial and residential real estate investments. It’s important because it provides the investor with a number that they can use to help determine if the property is a solid investment and a good deal.
Typically, a good cap rate is 4 to 10 percent or more, and it shows the ratio of the NOI to the property value. This means that an investor who purchases the property will be buying for a relatively low price in comparison to the property’s income production.
A cap rate is commonly used for:
- Purchasing an apartment building
- Purchasing a multifamily property
- Buying a piece of commercial property
- Purchasing a single-family home
- Purchasing a duplex, triplex or fourplex
- You’re a new landlord and want to evaluate your investment property quickly
“Cap rates are used by investors to understand what the rate of return is on a property in relation to the income generated by the asset. This is especially important when trying to compare various assets in the market. Understanding how the NOI impacts the market value of the property allows investors to decide if a property is worth the market rate being paid for the investment.”
— Veena Jetti, Founding Partner, Enzo Multifamily
Alternatives to Using a Cap Rate
As we outlined above, a cap rate can be a great tool to help investors decide if a property is a good investment. The cap rate formula can be used by residential and commercial real estate investors. However, it’s not always a good fit, especially if you’re buying land or property that you don’t plan to rent. We recommend using the cap rate, in addition to other things such as looking at comparable properties and their price per unit.
If you’re a fix-and-flip investor, the cap rate formula isn’t going to be helpful to you because you’re not going to be renting out the property. Instead, you can look at what comparable properties sell for, and what the after repair value (ARV) will be. The cap rate formula may not be applicable if a property needs to be fixed up before it’s rented or if it has a lot of vacancies and you’re not sure what the units will rent for.
Some alternative ways to evaluate a property include:
- The 1 percent rule: The gross monthly rental income should be a minimum of 1 percent of the purchase price, some investors use the 2 percent rule, depending on the property type and location; if the property’s gross monthly income is 1 percent or more of the purchase price, it’s usually cash-flow positive
- Gross rental yield: This number can be found by dividing the annual rent collected by the total property cost and then multiplying by 100; the total property cost includes the purchase price, closing costs and any renovation costs
- Cash flow: Evaluate the property’s potential cash flow by checking to see if the expected monthly rent will cover your costs including mortgage payment, taxes, insurance, utilities and homeowners’ association fees
- Comparable properties: Look at what other comparable properties have sold and rented for in the past three to six months; comparables should be the same type of property, have similar amenities and be similar in size
- Return on investment: Typically 10 percent or more is a good return on investment (ROI) for a real estate investment; you can figure out your ROI on an investment property by calculating your annual return and dividing that by your total cash investment; you figure out your annual return by subtracting your expenses from your total rental income
The Bottom Line
The cap rate is a tool to help real estate investors evaluate a residential or commercial investment property. The cap rate formula is net operating income divided by purchase price. Our free cap rate calculator does the calculations for you. You input a few things like the property value or your gross rental income, and it will calculate your NOI and your cap rate.
For more what’s a good cap rate and when to use it, check out our in-depth guide on cap rate formula.
If you’re looking for an investment property with a high cap rate, and need financing, check out Visio Lending. They’re a reputable online lender that offers investment property loans with competitive rates for prime borrowers. You can get prequalified online in just a few minutes.