Compare the property’s operating income with its price before your loan enters the picture. Use a target cap rate to see the value supported by the same income.
Cap rate = annual NOI ÷ property value. Implied value = annual NOI ÷ target cap rate.
WORKED EXAMPLE
Annual rent of $36,000, a 5% vacancy allowance, $1,200 other income, and $11,400 operating expenses produce $24,000 NOI. At a $300,000 value, the cap rate is 8%. The same NOI supports a $400,000 value at a 6% target cap rate.
Calculate net operating income first
Start with scheduled annual rent and deduct the vacancy allowance. Add recurring other income, then subtract ordinary property operating expenses such as taxes, insurance, management, repairs, utilities, and HOA charges. Enter annual numbers consistently. Loan payments, depreciation, income taxes, and major capital replacements are excluded from the NOI definition used on this page. A capital reserve still matters to cash flow, even though this model keeps it outside cap-rate NOI.
Use cap rate to compare the asset, not the loan
Two buyers using different loans can calculate the same cap rate for a property because financing does not change its modeled operating income. The metric is useful when comparing similar properties with comparable leases, condition, and operating assumptions. A higher cap rate is not automatically a better investment: it can reflect weaker demand, repair needs, income instability, or other risks. Review the source of the income instead of selecting the largest percentage in isolation.
Estimate value at a target yield
Dividing NOI by a target cap rate gives an implied income-based value. Raising the required cap rate reduces that value; lowering the required rate increases it. This sensitivity is helpful for negotiations and comparisons, but it does not replace an appraisal or establish an achievable sale price. A change in expenses or occupancy can alter NOI, so test the operating budget as well as the target rate. Use the rental calculator to add financing and cash flow.
A LITTLE MORE CLARITY
Frequently asked questions
Are mortgage payments included in cap rate?
No. Cap rate uses income before debt service. The mortgage belongs in a cash-flow or cash-on-cash analysis.
Should I use purchase price or current value?
Use purchase price to screen an acquisition, or a supportable current value to compare a property you own. Keep the basis consistent across properties.
What happens when NOI is negative?
The cap rate is negative. A positive target cap rate does not produce a meaningful positive income-based valuation from negative NOI; the calculator leaves that implied value unavailable.
