Capitalization rate is annual net operating income divided by a stated property price or value, expressed as a percentage.
Cap rate converts one year of stabilized property income into a simple unlevered yield indicator. It does not include mortgage terms, future rent growth, capital expenditures, taxes, or sale proceeds. Always pair the percentage with the NOI period and value basis.
How capitalization rate (cap rate) works
Normalize NOI first, choose and label the denominator—purchase price, current value, or underwritten value—and divide. To infer value under a direct-capitalization assumption, divide NOI by a market-supported cap rate; do not invent that market rate from the desired price.
Formula: cap rate = annual NOI ÷ stated property price or value × 100
Worked example
A $140,000 stabilized NOI divided by a $2,000,000 value produces a 7.0% cap rate. At the same NOI, a $2,333,333 value corresponds to about 6.0%, illustrating why small rate changes materially affect indicated value.
Common mistakes and review checks
Treat the result or document as one input to a decision. Verify the current source document, definitions, dates, and transaction facts before relying on it.
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Using gross rent instead of NOI.
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Comparing cap rates built from different expense or reserve definitions.
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Treating a cap rate as a forecast of total return or a universal risk score.
Related tools & guides
Editorial ownership
Written and maintained by the Aptoria editorial team
Content updated August 3, 2026. Editorial method reviewed July 28, 2026. Aptoria reviews scope, source fit, examples, limitations, links, and publication gates. This record does not claim attorney, CPA, lender, appraiser, or other independent professional sign-off.
Primary and authoritative sources
OCC Comptroller's Handbook: Commercial Real Estate Lending 2.0 ↗
NOI, DSCR, debt yield, capitalization-rate analysis, and warnings about normalizing property income and expenses.
Related terms
Investing metrics
Net operating income (NOI)
Net operating income is effective property income minus normalized property operating expenses, before debt service and owner-level income taxes.
Investing metrics
Cash-on-cash return
The annual pre-tax cash flow a property produces divided by the actual cash you invested in it.
Investing metrics
Gross rent multiplier (GRM)
A sale-price-to-gross-rent screening multiple whose monthly or annual rent convention must be stated.
Investing metrics
The 1% rule
A rough rule of thumb that a rental's monthly rent should be at least 1% of its total purchase price.
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