Capitalization rate — almost always shortened to cap rate — is the income return a property produces relative to its value, using income after operating costs but before any financing. It answers a clean question: if you bought this property outright with cash, what annual income return would it deliver?
Because it deliberately strips out the loan, the cap rate lets you compare the underlying earning power of properties on a like-for-like basis — regardless of how any particular buyer chooses to fund them. It is the lingua franca of commercial property, and increasingly useful in residential investing too.
The formula
Net operating income (NOI)
Annual rent − operating expenses
Income after the costs of running the property — rates, insurance, management, maintenance — but before mortgage repayments and tax. NOI is the true operating profit of the property itself.
Cap rate
NOI ÷ property value × 100
Divide net operating income by the property's value (or purchase price) to get the cap rate. A property with $30,000 of NOI valued at $600,000 has a cap rate of 5%.
A worked example
A property is valued at $650,000 and rents for $42,000 a year. Operating expenses — rates, insurance, management and maintenance — come to $9,000, so the net operating income is $33,000.
The cap rate is $33,000 ÷ $650,000 = 5.08%. If a comparable property down the road is selling on a 4.5% cap rate, this one offers a stronger income return for the price — a useful signal, though never the whole story.
Cap rate vs rental yield
Cap rate and net yield are close cousins — both divide an after-costs income figure by the property's value. In practice the terms are often used interchangeably in residential investing. The distinction is one of convention: cap rate is the standard language of commercial valuation and is always based on net operating income, while “yield” in residential contexts can refer to either the gross or net figure depending on who's speaking.
There's also an important relationship worth knowing: value = NOI ÷ cap rate. Rearranging the formula shows that if market cap rates fall, the value of a property with a given income rises — which is how income-producing property gets repriced as investor demand shifts.
What the cap rate leaves out
- Financing — it assumes an all-cash purchase, so it says nothing about your return once a loan is layered on.
- Capital growth — like yield, it captures income only, not the change in the property's value over time.
- Tax — it's a pre-tax measure and ignores depreciation and deductions.
- One-off and irregular costs — a smooth annual NOI can hide lumpy capital works that hit the real return.
Work out income return in seconds
Our rental yield calculator works through net income and value — the same inputs behind a cap rate — to show the income return on a property.
Open the rental yield calculator