What is Capitalization Rate (Cap Rate)?
Capitalization Rate (cap rate) is a property's annual NOI divided by its purchase price (or current market value), expressed as a percentage. It's an unlevered yield metric — the return an all-cash buyer would earn before financing.
Cap rate strips out financing to compare properties apples-to-apples. A 7% cap rate means an all-cash buyer earns 7% annually on their invested capital from operating cash flow alone. Higher cap rates mean better yields (or more risk); lower cap rates mean lower yields (or more appreciation expected).
Cap rate is a function of three things: NOI growth expectations, perceived risk, and the local interest rate environment. Class-A urban multifamily trades at 4-5% cap rates because investors expect rents to grow and tenants are stable. Class-C suburban rentals trade at 8-10% because rents grow slower and turnover is higher.
For single-family rentals, the right cap-rate range is 6-9% in most US markets in 2026. Anything above 10% deserves scrutiny — usually it means deferred maintenance, declining neighborhood, or rent assumptions that won't hold. Anything below 5% requires meaningful appreciation to make the deal pencil.
Purchase $200,000. NOI $14,000. Cap rate = $14,000 / $200,000 = 7.0%. A 7-cap deal in a stable suburban market with 6-month rent reserves is standard mid-tier underwriting.
Concepts that connect.
Net Operating Income (NOI) is a rental property's annual gross rental income minus all operating expenses, before debt service and income taxes. NOI is the denominator of cap rate and the numerator of DSCR — it's the most-used number in rental underwriting.
Debt Service Coverage Ratio (DSCR) is the ratio of a property's annual net operating income to its annual debt service. A DSCR of 1.20 means the property generates 20% more income than it needs to cover the loan payment. Most DSCR lenders require 1.10-1.25 to underwrite.
Cash-on-cash return is annual pre-tax cash flow divided by the total cash the investor put into the deal (down payment + closing + rehab + reserves). Unlike cap rate, it accounts for financing. The most useful metric for comparing leveraged investments.
Gross rent yield is annual gross rent divided by the property's purchase price (or current value), expressed as a percentage. It ignores operating expenses and is used as a quick first-pass screening metric. A 6% gross yield is roughly the floor for a viable rental in most US markets in 2026.
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