Cap Rate Formula: How to Calculate Cap Rate

The capitalization rate formula

Use the acquisition price when analyzing a potential purchase. Use current market value when measuring the return on a property you already own. Mixing an old purchase price with current income produces a historical yield, not a current market cap rate.

Step 1: calculate effective gross income

Add scheduled rent and stable sources such as parking, laundry, and storage. Then subtract a realistic allowance for vacancy and nonpayment. A property scheduled to collect $72,000 with $3,600 of expected vacancy has effective gross income of $68,400.

Step 2: calculate NOI

Subtract ordinary operating expenses from effective gross income. Typical expenses include property taxes, insurance, management, maintenance, owner-paid utilities, and association fees. Do not deduct mortgage payments, depreciation, income tax, or major capital projects.

Worked cap rate example

A $500,000 property earns $60,000 in effective annual income and costs $15,000 per year to operate. Its NOI is $45,000. Dividing $45,000 by $500,000 produces 0.09; multiplying by 100 gives a 9% cap rate.

Common calculation mistakes

• Using gross rent instead of income after vacancy.
• Counting mortgage payments as operating expenses.
• Leaving out management or maintenance because you self-manage.
• Comparing properties from different markets or asset classes.
• Treating cap rate as a forecast of total investment return.