What is a Cap Rate in Real Estate?
Cap rate is one of the most important metrics in real estate investing. Here is everything you need to know about cap rates - what they mean, how to calculate them, and how to use them to evaluate investments.
Cap Rate Definition
Cap rate (capitalization rate) is the annual return on a real estate investment based on the income it generates. It is calculated by dividing the net operating income by the property value. Cap rate is expressed as a percentage and is used to compare the potential return of different investment properties.
Cap Rate Formula
Cap Rate = Net Operating Income / Property Value
Expressed as a percentage
Cap Rate Example
A property worth $200,000 generates $20,000 in annual net operating income.
Cap Rate = $20,000 / $200,000 = 10%
This means the property generates a 10% annual return based on its value.
What is a Good Cap Rate?
Low cap rate
Typical in expensive markets like NYC or San Francisco. Lower risk, lower return.
Average cap rate
Typical in most mid-size markets. Balanced risk and return.
Good cap rate
Strong return, typically in smaller markets or value-add properties.
High cap rate
Very strong return but may indicate higher risk or less desirable location.
How to Calculate Net Operating Income
Net Operating Income (NOI) = Gross Rental Income - Operating Expenses
Example:
- Gross rental income: $24,000/year
- Property management: -$2,400
- Insurance: -$1,200
- Property taxes: -$2,400
- Maintenance: -$1,200
- NOI: $16,800/year
Cap Rate vs Cash on Cash Return
Cap rate measures return based on property value regardless of financing. Cash on cash return measures return based on actual cash invested. If you paid cash for a property, they are the same. If you used a mortgage, cash on cash return will be higher because you invested less cash upfront.
Cap Rates and Fractional Investing
When you invest through Pie Assets, our team analyzes cap rates and other metrics for every property before listing it. We target properties with strong cap rates that can deliver up to 15% total annual returns to investors through rental income and appreciation. You get the benefit of professional analysis without needing to calculate cap rates yourself.
Frequently Asked Questions
Is a higher cap rate always better?
Not always. A very high cap rate can indicate higher risk, a less desirable location, or a property needing work. Context matters.
Does cap rate include mortgage payments?
No - cap rate is calculated before mortgage payments. It measures the property return independent of financing.
What cap rates does Pie Assets target?
Pie Assets targets properties with strong cap rates that can deliver up to 15% total annual returns to investors.
