Complete guide
Reviewed July 2026Cap rate — capitalization rate — is real estate's price-to-earnings ratio inverted: the property's annual net operating income divided by its price. It answers the investor's first question — what does this asset earn, unlevered, relative to what it costs? — in one comparable percentage.
Because it strips out financing, cap rate lets you compare a Mumbai flat, a Dallas duplex and a warehouse on equal footing. It's also the language of commercial valuation: brokers quote markets in cap rates, and value is routinely computed as NOI ÷ market cap rate.
Enter NOI and property value above for the rate. Below: exactly what belongs in NOI (where most errors hide), benchmarks, and how cap rate relates to the metrics it's confused with.
Formula and the NOI that powers it
Cap rate = NOI ÷ Property value × 100 NOI = Gross rental income − vacancy & credit losses − property tax, insurance − maintenance & repairs − property management − utilities & common charges (owner-paid) Excluded: mortgage payments, depreciation, income tax, capex reserves*
NOI is where cap rates are won or lost. Sellers quote 'pro-forma' NOIs with zero vacancy and fantasy maintenance; buyers should rebuild NOI from actual rent rolls and trailing-12-month expenses. The metric excludes financing deliberately — cap rate describes the asset, not your loan.
Worked example
- Duplex priced at ₹1.6 crore; market rent ₹65,000/month → gross ₹7.8 lakh/year.
- Vacancy at 5%: −₹39,000. Property tax ₹45,000, insurance ₹18,000, maintenance ₹60,000, management (8%) ₹62,400.
- NOI = 7,80,000 − 39,000 − 45,000 − 18,000 − 60,000 − 62,400 = ₹5,55,600.
- Cap rate = 5,55,600 ÷ 1,60,00,000 = 3.47%.
- Valuation flip: if similar assets trade at a 4% cap, this NOI supports a value of 5,55,600 ÷ 0.04 = ₹1.39 crore — the asking price is ~15% rich.
What's a good cap rate?
There is no universally 'good' number — cap rate prices risk and growth. Low cap rates signal safe, appreciating markets (you pay up for the asset); high cap rates signal risk, weak growth or management burden (the income compensates). The useful comparison is against similar assets in the same submarket, and against your financing cost.
| Asset / market | Typical cap rate | What it signals |
|---|---|---|
| Indian metro residential | 2–4% | Appreciation-driven market; income is secondary |
| Indian commercial (Grade A office) | 7–9% | Income-driven; institutional pricing |
| US prime multifamily | 4–5.5% | Low risk, low growth premium priced in |
| US secondary/tertiary markets | 6–8% | Higher yield, higher vacancy/tenant risk |
| Value-add / distressed | 8%+ | Pricing compensates for work and risk |
Cap rate vs the metrics it's confused with
The spread between cap rate and loan interest rate is the leverage test: borrowing at 9% to buy a 3.5% cap asset means debt eats the income (negative leverage) and the investment is purely an appreciation bet. Positive-leverage deals — cap rate above borrowing cost — let financing amplify returns instead of consuming them.
| Metric | Formula | Includes financing? | Best for |
|---|---|---|---|
| Cap rate | NOI ÷ value | No | Comparing assets; valuation |
| Gross rental yield | Annual rent ÷ value | No (and no expenses!) | Quick screening only |
| Cash-on-cash | Pre-tax cash flow ÷ cash invested | Yes | Your actual levered return |
| IRR | Time-weighted total return | Yes | Full-hold analysis incl. sale |
Using this calculator well
- Rebuild NOI yourself: actual rents, honest vacancy (ask local managers), trailing-year expenses, plus management even if self-managing (your time isn't free).
- Divide by the true all-in price — including stamp duty, brokerage and immediate repairs.
- Compare against recent comps' cap rates in the same micro-market and against your loan rate.
- Invert for valuation: NOI ÷ market cap rate = what the income justifies paying.
Common mistakes
- Using gross rent instead of NOI — the single biggest inflation of quoted returns.
- Accepting pro-forma NOI: zero vacancy and ₹0 maintenance exist only in listings.
- Ignoring management costs because you'll self-manage — you're buying a job, not a yield.
- Comparing cap rates across different capex conventions or across unlike submarkets.
- Treating a high cap rate as a bargain rather than a risk price — cheap assets are usually cheap for reasons the NOI hasn't met yet.
Frequently asked questions
Glossary
- Cap rate
- NOI ÷ property value — the unlevered income return at a given price.
- NOI
- Net operating income: rents minus operating expenses, before financing and income tax.
- Pro-forma
- Projected (often optimistic) figures a seller presents, versus trailing actuals.
- Income capitalization
- Valuing property as NOI ÷ market cap rate.
- Cash-on-cash
- Annual pre-tax cash flow ÷ total cash invested — the levered return.
- Positive leverage
- Cap rate exceeding borrowing cost, so debt boosts returns.
- Cap-rate compression
- Market-wide fall in cap rates, inflating values for the same income.
- Exit cap
- The assumed cap rate at future sale — a key driver in IRR models.
Key takeaways
Cap rate = honest NOI ÷ true all-in price: the clean, financing-free way to compare income property and to convert income into value. Rebuild NOI from actuals (vacancy, management and maintenance included), read the rate against local comps and your borrowing cost, and remember what the number is: a market price for risk and growth — not a scoreboard where higher automatically wins.
Compute the cap rate on the property you're eyeing above — then invert the market cap rate and see what its income actually justifies paying.