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How to Calculate Cap Rate

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Rental Tips

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This tutorial is based on the Omni Calculator Cap Rate Calculator tool.

Step 1: Understand the Formula
The formula for the capitalization rate (cap rate) is:

Cap Rate=(Net Operating Income (NOI)Property Value (or Purchase Price))×100\text{Cap Rate} = \left( \frac{\text{Net Operating Income (NOI)}}{\text{Property Value (or Purchase Price)}} \right) \times 100Cap Rate=(Property Value (or Purchase Price)Net Operating Income (NOI)​)×100


Step 2: Gather the Necessary Information
You need two main inputs:

  1. Net Operating Income (NOI): This is your annual rental income minus operating expenses.
    • Example: Annual Rental Income = $30,000; Annual Operating Expenses = $6,000 NOI=30,000−6,000=24,000\text{NOI} = 30,000 – 6,000 = 24,000NOI=30,000−6,000=24,000
  2. Property Value or Purchase Price: The market value or the amount paid for the property.
    • Example: Property Value = $300,000

Step 3: Plug in the Numbers
Divide the NOI by the property value and multiply by 100 to express it as a percentage.

Cap Rate=(24,000300,000)×100=8%\text{Cap Rate} = \left( \frac{24,000}{300,000} \right) \times 100 = 8\%Cap Rate=(300,00024,000​)×100=8%


Step 4: Interpret the Result
The result is the percentage return you can expect annually on your investment:

  • In this example, an 8% cap rate means you earn 8% of the property value annually as income.

Optional: Adjust for Additional Parameters

  • Vacancy Rate: If the property isn’t rented 100% of the time, reduce income accordingly.
  • Operating Expenses Percentage: Calculate expenses as a percentage of gross income for more accurate results.

Step 5: Evaluate the Cap Rate

  • Compare the cap rate with similar properties or the market average to determine if it’s a good investment.
  • General guideline:
    • Higher Cap Rate (8-12%): Indicates higher returns but may come with more risk.
    • Lower Cap Rate (4-7%): Suggests lower returns but typically less risk.

Practical Application:
Use the cap rate to:

  • Evaluate the profitability of a potential purchase.
  • Determine a property’s value if the cap rate and NOI are known.

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