Cap rate is one of the most used — and most misunderstood — metrics in real estate investing. Investors throw the term around constantly, but few can explain exactly what it means, what makes one good or bad, and how to actually use it to make decisions.
Here's everything you need to know.
Cap rate (capitalization rate) is the annual return a property generates on its value, assuming you paid all cash with no financing. It's a way to measure how much income a property produces relative to what it costs.
If a property is worth $400,000 and generates $28,000 in net operating income per year, the cap rate is 7%.
NOI is the annual income the property generates after operating expenses — but before mortgage payments and taxes. It includes:
It does not include mortgage principal and interest, depreciation, or income taxes. This is why cap rate is financing-agnostic — it measures the property, not the deal structure.
The answer depends entirely on the market. Cap rates vary significantly by location, property type, and market conditions.
| Market Type | Typical Cap Rate Range | What It Signals |
|---|---|---|
| Major gateway cities (NYC, SF, LA) | 3–4% | Appreciation play, minimal cashflow |
| Mid-size metros (Atlanta, Tampa, Phoenix) | 5–7% | Balanced cashflow and growth |
| Secondary markets (Memphis, Cleveland) | 7–10% | Strong cashflow, lower appreciation |
| Rural and tertiary markets | 10%+ | High yield, higher risk |
As a general rule, 6% or higher is considered solid in most markets. Below 5% means you're paying a premium and relying on appreciation to generate returns.
A higher cap rate is not always better. In markets with strong appreciation, a 4% cap rate property might outperform a 9% cap rate property over 10 years once you factor in equity growth.
This is where most newer investors get confused. Cap rate and cash on cash measure different things:
A property with a 7% cap rate financed at 7.5% interest will likely have a negative or near-zero cash on cash return — the mortgage eats the income. Cap rate alone doesn't tell you if a deal works with today's rates.
There's a concept called the "spread" — the difference between the cap rate and the financing rate. When interest rates are low, you can finance a 5% cap rate property at 3.5% and still generate strong returns. When rates are at 7.5%, that same 5% cap rate deal loses money every month.
In today's rate environment, targeting properties with cap rates at or above the prevailing mortgage rate is a reasonable baseline — though markets, property condition, and your strategy all affect the equation.
Cap rate is most useful as a screening tool, not a final decision metric. Before you run full numbers on a property, calculate the cap rate to see if it's even worth your time. A quick estimate using market rents and the asking price will tell you whether to dig deeper or move on.
Propivo calculates cap rate automatically for every analysis using live rent estimates and comparable sales data — so you get an accurate number in seconds without pulling comps manually.