Capitalization Rate (Cap Rate)
The unlevered return on a property, independent of financing.
Formula
Cap Rate = NOI / Property Value
NOI is annual Net Operating Income (rent minus operating expenses, excluding mortgage). Property Value is purchase price or current market value.
What Is It?
Cap rate tells you the annual return you would earn if you bought the property entirely in cash. It strips out the effect of financing, making it ideal for comparing properties regardless of how they are funded.
Worked Example
A $500K property rents for $3,000/mo with $1,200/mo in operating expenses.
| Annual Gross Rent | $36,000 |
| Annual Operating Expenses | $14,400 |
| NOI | $21,600 |
| Property Value | $500,000 |
Why It Matters
- ✓Compare properties across different price points on an apples-to-apples basis
- ✓Gauge market sentiment — low cap rates signal high demand / expensive markets
- ✓Quickly screen deals — if cap rate is below your threshold, move on
- ✓Used in commercial valuations: Value = NOI / Cap Rate
What's Good vs Bad?
Excellent
8%+ (rare in coastal CA)
Good
5–7%
Poor
Below 4%
Limitations
- ⚠Ignores financing — a 4% cap rate property can still cashflow well with leverage
- ⚠Assumes stable NOI — doesn't account for deferred maintenance or rent growth
- ⚠Varies by market — 4% in San Diego is normal; 4% in the Midwest is low
- ⚠Doesn't capture appreciation or tax benefits
How Prop2Profit Uses This Metric
Prop2Profit calculates cap rate for every listing using estimated rent via our proprietary algorithm and standard operating expense assumptions. Cap rate contributes 30 of 100 points to the investment score.