Capitalization rate — "cap rate" for short — is the single number most investors quote when comparing rental properties. It strips away financing, taxes, and operating quirks to ask one question: if you bought this property in cash, what annual return would the building itself produce?
This guide covers the formula, a worked example you can stress-test in the calculator below, and four ways cap rate can mislead you if you treat it as the whole answer.
The formula
Cap rate is net operating income divided by purchase price:
Cap rate = Net Operating Income ÷ Property Price
Both numbers are annual. The result is a percentage. A property earning $30,000 in NOI on a $400,000 purchase has a 7.5% cap rate.
Why exclude financing? Because two investors can buy the same building with very different loans, and you want to compare the property — not the deal.
A worked example
Take a duplex listed at $400,000 in a midsize Sun Belt market:
- Each unit rents for $1,400/month → $33,600/year gross rent
- Vacancy allowance (one month/year per unit) → −$2,800
- Property taxes (1.8% effective rate) → −$7,200
- Insurance, management (8%), maintenance reserve (5%) → −$5,100
- NOI: $18,500 → cap rate: 4.6%
Try plugging different numbers into the calculator below — what happens if the listing price drops to $350,000? What if rents rise 10%?
Try it: Cap Rate Calculator
This calculator applies a standardized assumption (typically 40% of gross rent for expenses) and does not account for property-specific taxes, insurance, capital expenditures, vacancy, or financing. Actual cap rates vary by deal. Not a substitute for professional analysis.
When cap rate misleads
Cap rate is useful but incomplete. Four common failure modes:
1. Appreciation markets compress it
In Austin, Denver, or San Diego, prices have outpaced rents for years. A property with a 3.5% cap rate isn't necessarily a bad investment — it might be a great one if appreciation runs 6–8% annually. Cap rate measures income return only; total return = income + appreciation.
Conversely, a 10% cap rate in a stagnant or shrinking market may reflect that no one expects the asset to gain value.
2. Leverage changes the math entirely
Cap rate is unleveraged by design. The moment you finance the purchase, your cash-on-cash return diverges. A property with a 6% cap rate financed at 70% loan-to-value with a 6.5% mortgage rate is roughly break-even after debt service — sometimes negative when accounting for maintenance. The cap rate looked fine; the actual cash flow doesn't.
3. Pro-forma vs. trailing NOI
Sellers love presenting pro-forma cap rates: "this property will generate $X if you raise rents 15% and cut management costs." Always demand the trailing-twelve-month actuals. If the gap between pro-forma and trailing is large, you're really buying a plan, not a property.
4. Capex isn't in NOI
NOI excludes capital expenditures. A 7% cap rate property that needs a $30,000 roof in year two has a much worse real return than that number suggests. Always reserve 5–10% of gross rent for capex, or you'll find the cash flow vanishes the first time the HVAC fails.
What counts as a "good" cap rate?
A good cap rate is usually 4–10%, but the honest answer is that it depends entirely on the market and what you're trying to earn. A 4% cap rate can be excellent in a fast-appreciating coastal market and mediocre in a stagnant one; a 10% cap rate can signal either a genuine cash-flow machine or a market no one expects to gain value. The number only means something once you know the kind of market it came from.
To make that concrete, here is what cap rates actually look like across US metros right now — measured across every ZIP we track, not pulled from a rule of thumb.
Cap rates by metro — standardized, as of May 2026
| Metro | Typical home value | Cap rate* | Gross yield | Type |
|---|---|---|---|---|
| San Francisco–Oakland–Fremont, CA | $1,187,050 | 1.9% | 3.2% | Coastal Class-A |
| Los Angeles–Long Beach–Anaheim, CA | $920,507 | 2.2% | 3.6% | Coastal Class-A |
| New York–Newark–Jersey City, NY-NJ | $708,265 | 2.9% | 4.8% | Coastal Class-A |
| Nashville, TN | $433,635 | 2.9% | 4.8% | Sun Belt |
| Austin–Round Rock, TX | $415,653 | 2.9% | 4.8% | Sun Belt |
| Phoenix–Mesa–Chandler, AZ | $445,318 | 2.9% | 4.8% | Sun Belt |
| Columbus, OH | $334,379 | 3.3% | 5.5% | Midwest |
| Kansas City, MO-KS | $329,212 | 3.5% | 5.9% | Midwest |
| Indianapolis, IN | $295,397 | 3.9% | 6.5% | Midwest |
| Detroit–Warren–Dearborn, MI | $283,834 | 3.7% | 6.2% | Distressed/tertiary |
| Cleveland, OH | $252,194 | 4.1% | 6.8% | Distressed/tertiary |
| Memphis, TN-MS-AR | $243,350 | 4.5% | 7.5% | Distressed/tertiary |
A few things the data makes obvious:
- Coastal Class-A sits below 3%. San Francisco's 1.9% isn't a bad investment signal — it's a market where buyers price in appreciation and prestige, not current income.
- Sun Belt growth markets cluster around 2.9%. Austin, Nashville, and Phoenix have seen prices outrun rents for a decade, compressing yields into near-coastal territory. Austin's 78704 is the textbook case — strong rent, strong appreciation, thin yield.
- The Midwest crosses into income territory. Columbus, Kansas City, and Indianapolis (3.3–3.9%) are where the metric starts rewarding cash-flow buyers.
- Distressed metros only inch past 4% at the metro level — because the metro average blends rough and recovering neighborhoods. The eye-popping yields live one level down, at the ZIP scale.
The same metric, a 10× spread — at the ZIP level
Metro averages hide the real range. Drop to individual ZIPs and the same standardized cap rate stretches almost tenfold:
| ZIP | City, State | Typical home value | Cap rate* | Gross yield |
|---|---|---|---|---|
| 78704 | Austin, TX | $731,436 | 1.8% | 3.1% |
| 43215 | Columbus, OH | $333,991 | 3.4% | 5.6% |
| 46201 | Indianapolis, IN | $155,952 | 5.6% | 9.3% |
| 48224 | Detroit, MI | $82,764 | 11.4% | 19.0% |
| 48213 | Detroit, MI | $46,663 | 18.0% | 29.9% |
From 1.8% in Austin's 78704 to 18.0% in Detroit's 48213 is a roughly tenfold spread on the same metric, in the same country, the same month. And this is exactly where cap rate stops being a "good/bad" verdict and becomes a question you have to interrogate. Detroit's 48213 shows an 18% cap rate because homes there are priced around $47,000 — that number is real (it tops our highest rental-yield ranking), but it's compensation for risk: thin appreciation, higher vacancy, management headaches, and capital expenditures that the standardized 40% margin doesn't fully capture. A high cap rate isn't a free lunch; it's the market pricing in everything that makes the cash flow hard to keep.
The trap to avoid: comparing cap rates across markets. A 4% cap rate in Memphis and a 4% cap rate in San Francisco are different products. The Memphis property is priced for income; the San Francisco one would be a clearance sale. Use cap rate to compare like with like — same submarket, same asset class — never as a cross-country leaderboard.
Cap rate vs. gross rental yield
Gross rental yield is simpler: annual rent divided by purchase price, no expenses subtracted. It's faster to estimate from listing data but overstates return. Cap rate is the honest cousin.
If you see a property quoted at "10% yield," divide by roughly 1.6–2x to estimate the realistic cap rate — that's the rule-of-thumb adjustment for operating expenses in residential rentals (sometimes called the "50% rule").
When to actually use it
Cap rate earns its keep in three specific decision contexts:
- Comparing two properties in the same submarket. Same school district, same kind of building, similar age — cap rate is the cleanest apples-to-apples comparison.
- Sanity-checking a listing price. If everything comparable trades at 6% and this property is priced to yield 4%, you're either missing something the seller knows, or the price is wrong.
- Setting an offer. Decide what cap rate you need, and work backward to the price you can pay: Price = NOI ÷ target cap rate.
Where it falls down: comparing across markets, comparing across asset classes, and pretending it tells you anything about your actual cash flow.
Frequently asked
What is a good cap rate for a rental property? Generally 4–10%, depending on the market. In appreciation-driven coastal and Sun Belt markets, 2–4% can be normal and still produce strong total returns; in the Midwest and distressed markets, 4% and up is common because buyers are paying for income rather than price growth. There is no single "good" number divorced from the market.
Is a higher cap rate always better? No. A higher cap rate usually means a lower price relative to rent — which often reflects higher risk: weaker appreciation, higher vacancy, more maintenance, and tougher management. A 12%+ cap rate in a distressed ZIP is the market pricing in everything that makes the income hard to actually collect. Higher cap rate means higher current income and higher risk, not "better."
What's a good cap rate in 2026? Across the metros we track, standardized cap rates currently run from about 1.9% (San Francisco) to 4.5% (Memphis), with individual ZIPs ranging far wider. A mid-single-digit cap rate is solid for a cash-flow-oriented purchase in 2026; coastal and Sun Belt buyers should expect lower and rely on appreciation for total return.
Why is the cap rate on this page different from one I calculated myself? Likely because of the expense assumption. Our standardized cap rate estimates net operating income as 60% of gross rent (a flat 40% expense margin) so markets stay comparable. Your own calculation may itemize a specific local tax rate, management fee, vacancy, and capital reserves for one property — which is the right approach when underwriting a single deal. Use the standardized figure to compare markets; itemize to underwrite.
Next steps
For that last problem — converting cap rate into the after-financing return you'll actually pocket — the rental yield calculator is the next stop. And to put any cap rate in context for a specific ZIP, the decision guide for evaluating a rental market walks through the five-step process I use.