- What is a cap rate and how is it calculated?
- Cap rate (capitalization rate) measures a rental property's income potential independent of financing. It's calculated as Net Operating Income (NOI) ÷ Property Value × 100. A property worth $350,000 generating $21,000 NOI has a 6% cap rate. It lets you compare deals across different markets and price points on equal footing.
- What is a good cap rate?
- It depends on the market and asset class. As a general benchmark: 8%+ is considered strong, 5–8% is moderate, and below 5% is typical in high-demand urban markets where appreciation potential is priced in. A higher cap rate usually means more income relative to price — but can also reflect higher risk or a less desirable location.
- Does cap rate include the mortgage payment?
- No — cap rate is calculated before debt service. It treats the property as if purchased with cash. This is intentional: it lets you evaluate the property's income-generating ability on its own, regardless of how it's financed. To factor in your specific financing, use cash-on-cash return instead.
- What's the difference between cap rate and cash-on-cash return?
- Cap rate ignores financing and compares NOI to the full property value. Cash-on-cash return compares annual pre-tax cash flow (after mortgage payments) to the cash you actually invested (down payment + closing costs). Cap rate is better for comparing properties; cash-on-cash return is better for evaluating your actual return on invested capital.
- What should I include in 'Other Annual Expenses'?
- Other expenses can include HOA fees, utilities you pay as the landlord, landscaping, pest control, tenant screening costs, legal and accounting fees, advertising/listing fees, and any capital reserve contributions. A common rule of thumb is to budget 1% of property value per year for repairs and maintenance across all expense categories.
