In short
A commercial real estate cap rate is annual net operating income divided by property value, expressed as a percentage. Use cap rate to compare property-level income returns before debt, then test the same deal with loan-to-value, debt yield, and DSCR before treating the result as an acquisition decision.
- Cap rate = annual NOI ÷ property value × 100.
- A $150,000 NOI on a $2,000,000 property produces a 7.5% cap rate.
- Cap rate does not show the loan payment, required equity, refinance exposure, or debt-service coverage.
- A 5%, 6%, or 7.5% cap rate is not automatically good or bad without comparable properties, income durability, and financing assumptions.
On this page
- What is this property's cap rate?
- Which numbers belong in a cap rate calculation?
- How do cap rate, property value and loan underwriting fit together?
- What makes a cap rate good for this deal?
- What else do investors ask about cap rates?
- What should you do after you calculate cap rate?
What is this property's cap rate?
Calculate cap rate by dividing annual net operating income, or NOI, by the property value and multiplying by 100. For an acquisition, use the agreed purchase price; for an owned property, use the value you are testing, provided the NOI and value reflect the same point in time.
Use this cap rate calculator worksheet:
| Input | Calculation | Example |
|---|---|---|
| Annual effective gross income | Income after vacancy and credit loss | $260,000 |
| Annual operating expenses | Property-level operating costs | $110,000 |
| Annual NOI | Income minus operating expenses | $150,000 |
| Purchase price or tested value | Use one consistent valuation basis | $2,000,000 |
| Cap rate | $150,000 ÷ $2,000,000 × 100 | 7.5% |
The formula is:
Cap rate = (annual NOI ÷ property value) × 100
The reverse formulas are useful when a broker quotes a market cap rate or an investor has a target return:
Estimated value = annual NOI ÷ cap rateRequired NOI = property value × cap rate
For example, $150,000 of annual NOI at a 7.5% cap rate indicates a value of $2,000,000. At the same NOI, a 6.5% cap rate indicates about $2,307,692 of value, while an 8.5% cap rate indicates about $1,764,706. Those are valuation indications, not appraisals.
Cap rate is only as credible as the income and expense assumptions behind NOI. Keep the income period, vacancy assumption, expense treatment, and property value basis consistent before comparing two deals.
Which numbers belong in a cap rate calculation?
A cap rate calculation needs annual NOI and a value denominator. NOI starts with the property’s effective income and subtracts operating expenses, while mortgage principal and interest stay outside the basic cap-rate formula.
For a first-pass calculation, begin with rent and other recurring property income. Deduct vacancy and credit loss, then subtract recurring operating costs such as property taxes, insurance, utilities paid by the owner, management, routine repairs, payroll, and contract services.
Fannie Mae defines NOI for multifamily underwriting as effective gross income minus operating expenses. Its definition is useful as a reminder that NOI measures property operations before debt service, even though an individual lender may adjust revenue and expenses during underwriting. Fannie Mae's NOI definition supports that distinction. (mfguide.fanniemae.com)
Do not add mortgage payments to operating expenses just to make the cap rate look lower. That mixes property performance with a chosen capital structure. Also avoid treating capital improvements, leasing costs, reserves, or one-time repairs as interchangeable with routine operating expenses. Those items may matter greatly to a buyer and a lender, but they should be handled consistently in the investment model rather than inserted selectively.
The useful discipline is simple: calculate a trailing cap rate from documented operations, then calculate a forward cap rate from clearly labeled assumptions. Never present a projected cap rate as if it were a historical result.
How do cap rate, property value and loan underwriting fit together?
Cap rate answers what the property produces before debt. Loan underwriting asks a different set of questions: how much debt the property can support, whether the annual debt service is covered, and whether the requested loan is reasonable relative to value.
Use the same assumptions to calculate four separate screens:
| Metric | Formula | What it helps answer |
|---|---|---|
| Cap rate | NOI ÷ value | What is the unfinanced income return implied by the price or value? |
| Loan-to-value | Loan amount ÷ value | How much of the value is financed? |
| Debt yield | NOI ÷ loan amount | How much property income supports each dollar of debt? |
| DSCR | Net cash flow ÷ annual debt service | Does the property cash flow cover scheduled debt service? |
Using the prior example, a $2,000,000 purchase with $150,000 NOI has a 7.5% cap rate. If the proposed loan is $1,400,000, the loan-to-value ratio is 70% and the debt yield is 10.7%. If annual debt service is $112,000, a simple NOI-based coverage calculation is 1.34x.
That 1.34x figure is only a screening result. Fannie Mae's Multifamily Guide, effective June 23, 2026, defines underwritten DSCR as underwritten net cash flow divided by annual debt service, and its income adjustments can differ from an investor's quick NOI model. Review the current Fannie Mae definition of underwritten DSCR before assuming that a lender will use your exact numerator. (mfguide-acpt.fanniemae.com)
This is why a property can show an appealing cap rate and still fail a financing screen. The loan amount may be too high, the payment may be too large, the lender may underwrite lower income, or the asset may need more reserves and capital spending than the preliminary model reflects. For a broader view of documents and ratios used in credit review, see what lenders review before approving a commercial loan.
Cap rate starts the property conversation; debt yield and DSCR show whether the proposed debt structure can survive underwriting.
What makes a cap rate good for this deal?
A good cap rate is one that compensates for the property’s location, tenancy, lease structure, condition, income durability, required capital, and financing plan. A number alone cannot tell an acquisition team whether the price is attractive.
A lower cap rate means the buyer is paying more for each dollar of NOI. That may be rational when income is stable, the property is in a strong location, leases are durable, or future income growth is well supported. It may be risky when the low rate depends on aggressive rent growth, below-market expense assumptions, near-term lease rollover, or deferred repairs.
A higher cap rate means the buyer is paying less for each dollar of NOI. That can reflect opportunity, but it can also reflect higher risk, weaker demand, operating complexity, tenant concentration, short leases, property condition, or a market that requires more return for uncertainty.
Compare cap rates only among genuinely comparable assets. A stabilized apartment property, a single-tenant retail building, a lease-up self-storage facility, and a transitional office property can all show the same cap rate while carrying very different income and refinancing risk. Teams pursuing apartments should also consider how the acquisition structure fits multifamily acquisition financing.
The decision is not to find the highest cap rate. The decision is to identify whether the cap rate is supported by credible NOI, comparable transactions, and a loan structure the property can carry.
What else do investors ask about cap rates?
The calculator answers the arithmetic. These questions address what the percentage means in a real acquisition review.
How do you calculate the cap rate?
Calculate cap rate by dividing a property's annual net operating income by its purchase price or current market value, then multiplying by 100. A property with $150,000 of annual NOI and a $2,000,000 purchase price has a 7.5% cap rate because $150,000 divided by $2,000,000 equals 0.075.
What does 7.5% cap rate mean?
A 7.5% cap rate means the property generates annual NOI equal to 7.5% of the price or value used in the calculation, before debt service. At a $2,000,000 value, a 7.5% cap rate equals $150,000 of annual NOI. It does not reveal the mortgage payment, equity contribution, or investor cash return.
Is a 5% cap rate good?
A 5% cap rate can be reasonable when the property has durable income, strong location, reliable tenants, and limited capital needs, but it can also signal that the buyer is paying a high price for current NOI. Compare the 5% cap rate with similar recent transactions and test whether the proposed loan still meets coverage requirements.
Is 6% a good cap rate?
A 6% cap rate means annual NOI equals 6% of the property value used in the calculation. A $3,000,000 property at a 6% cap rate produces $180,000 of annual NOI. Whether 6% is good depends on the property's risk, income quality, projected expenses, and the debt structure required to acquire it.
A percentage becomes useful only when the underlying NOI, comparable properties, and financing assumptions are visible beside it.
What should you do after you calculate cap rate?
Use the cap rate as a first screen, not a final approval. Confirm the rent roll and trailing expenses, separate recurring operations from capital needs, test conservative forward NOI, and run loan-to-value, debt yield, DSCR, monthly payment, and balloon balance using the same valuation assumptions.
A cap-rate valuation does not calculate the payment or maturity balance. Use a commercial property loan calculator to test amortization and balloon exposure alongside the cap-rate screen.
For an acquisition where the property economics look viable but the debt structure is unclear, request commercial financing guidance before committing to a price or financing contingency.