What is a good cap rate for a rental property?

A good cap rate depends on the market and property type. In major metros like San Francisco or New York, 3% to 5% is common. In secondary and tertiary markets, 6% to 10% is typical. Generally, a higher cap rate signals higher potential returns but also higher risk.

How do you calculate cap rate?

Cap rate equals Net Operating Income (NOI) divided by the property's current market value or purchase price, expressed as a percentage. For example, a property with $18,000 NOI and a $300,000 value has a 6% cap rate.

Does cap rate include mortgage payments?

No. Cap rate is calculated before any debt service. It uses Net Operating Income, which excludes mortgage principal and interest. This makes cap rate useful for comparing properties regardless of how they are financed.

Why do cap rates vary so much between markets?

Cap rates reflect the risk and growth expectations of a market. Low cap rates in expensive metros indicate investors expect strong appreciation and lower risk. Higher cap rates in smaller markets compensate for less liquidity, slower appreciation, and higher perceived risk.

Should I only buy properties with high cap rates?

Not necessarily. A high cap rate may signal higher risk, deferred maintenance, or a declining neighborhood. Meanwhile, a low cap rate property in a strong market may deliver better total returns through appreciation. Consider cap rate alongside cash flow, appreciation potential, and your investment goals.

What is a Good Cap Rate? Cap Rate Explained for Investors (2026)

What Is Capitalization Rate?

Capitalization rate, commonly called cap rate, is one of the most widely used metrics in real estate investing. It measures the annual rate of return on a property based on its income, independent of financing. In simple terms, cap rate tells you how much income a property generates relative to its price. If you buy a rental property for $250,000 and it produces $15,000 in net operating income per year, the cap rate is 6%. Investors use cap rate to quickly compare properties, evaluate markets, and determine whether a deal makes financial sense before diving into detailed cash flow analysis.

The Cap Rate Formula

The formula is straightforward:

Cap Rate = (Net Operating Income / Property Value) x 100

Net Operating Income (NOI) is annual rental income minus all operating expenses, including property taxes, insurance, maintenance, property management fees, and vacancy reserves. It does not include mortgage payments. Property Value is typically the purchase price for acquisitions or the current market value for existing holdings.

For example, say you are evaluating a duplex listed at $400,000. The property generates $3,200 per month in gross rent ($38,400 annually). After subtracting $14,400 in annual operating expenses, the NOI is $24,000. The cap rate would be $24,000 / $400,000 = 6.0%.

Try it yourself:

Cap Rate Calculator

Annual Net Operating Income ($)

Property Market Value ($)

Cap Rate Ranges by Market Type

Cap rates vary significantly depending on location, property class, and economic conditions. Here is a general breakdown for residential rental properties in 2026:

•Major metros (3% to 5%): Cities like San Francisco, New York, Los Angeles, and Seattle. High demand and strong appreciation expectations compress cap rates. A $750,000 condo producing $27,000 NOI yields a 3.6% cap rate.
•Mid-tier cities (5% to 7%): Markets like Nashville, Raleigh, Denver, and Tampa. These offer a balance of cash flow and appreciation. A $350,000 single-family rental with $21,000 NOI delivers a 6% cap rate.
•Secondary and tertiary markets (7% to 10%): Smaller cities and rural areas such as Memphis, Cleveland, or Wichita. Higher cap rates compensate for slower appreciation and less liquidity. A $150,000 triplex generating $13,500 NOI hits a 9% cap rate.

Cap Rate Ranges by Property Type

Different property types carry different risk profiles, which is reflected in their cap rates:

•Single-family rentals: Typically 4% to 8% depending on location. Lower operational complexity but also a single income stream.
•Small multifamily (2 to 4 units): Usually 5% to 9%. Multiple income streams reduce vacancy risk, and these properties still qualify for residential financing.
•Large multifamily (5+ units): Ranges from 4% to 8%. Institutional-grade apartments in prime locations trade at lower cap rates, while value-add properties in secondary markets trade higher.
•Short-term rentals: Cap rates of 6% to 12% are common, reflecting higher income potential but also more volatility, heavier management demands, and regulatory risk.

Factors That Affect Cap Rate

Many variables push cap rates up or down. Understanding these helps you interpret what a cap rate is really telling you:

•Interest rates: When borrowing costs rise, investors demand higher returns, pushing cap rates up. When rates fall, cap rates tend to compress.
•Local supply and demand: Markets with limited housing supply and strong population growth see compressed cap rates because more buyers compete for fewer deals.
•Property condition: A well-maintained property with recent upgrades will command a lower cap rate (higher price) than a deferred-maintenance property of similar size in the same area.
•Tenant quality: Properties with long-term, creditworthy tenants and strong lease terms carry lower risk, which translates to lower cap rates.
•Neighborhood trajectory: Improving neighborhoods see cap rate compression over time as values rise faster than rents. Declining areas experience cap rate expansion.

Compressed vs. Expanded Cap Rates

When cap rates compress, it means property values are rising faster than NOI. This typically happens in hot markets where investor demand is strong, interest rates are low, and expectations for appreciation are high. A market that had 7% cap rates five years ago might sit at 5% today if values have climbed sharply.

Cap rate expansion is the opposite. Values drop or stagnate while rents hold steady (or rents fall while values decline faster). This often occurs during economic downturns, rising interest rate environments, or when a market becomes oversupplied. For buyers, expansion can create opportunity: the same NOI stream becomes available at a lower price. For sellers, it means reduced equity and potentially negative leverage if the cap rate exceeds the cost of debt.

Consider a practical example. In 2021, a 10-unit apartment building in Austin, TX, sold for $2,000,000 with $100,000 NOI, reflecting a 5% cap rate. By 2024, interest rates had risen and buyer demand cooled. A comparable building with the same $100,000 NOI might trade at $1,430,000, reflecting a 7% cap rate. Same income, very different pricing.

When Cap Rate Matters (and When It Does Not)

Cap rate is a powerful screening tool, but it has limits. Here is when to lean on it and when to look elsewhere:

Cap rate is most useful when:

•Comparing similar properties in the same market to identify relative value.
•Evaluating whether a market is overpriced or underpriced relative to rents.
•Quickly screening deals before conducting a full financial analysis.

Cap rate falls short when:

•You need to account for financing. Cap rate ignores leverage entirely, so two identical cap rate deals can produce very different cash-on-cash returns depending on the loan terms.
•Comparing properties across very different markets. A 5% cap rate in San Francisco and a 5% cap rate in rural Ohio represent entirely different risk profiles.
•Evaluating value-add opportunities where current NOI does not reflect the property's potential after renovations and rent increases.

Real-World Cap Rate Examples

Let us walk through three real-world scenarios to see cap rate in action:

Example 1: Single-Family Rental in Phoenix, AZ

Purchase price: $320,000. Monthly rent: $2,100 ($25,200/year). Annual operating expenses: $8,700 (taxes $3,200, insurance $1,600, maintenance $2,400, vacancy reserve $1,500). NOI: $25,200 minus $8,700 = $16,500. Cap rate: $16,500 / $320,000 = 5.2%. This is typical for a mid-tier metro in 2026.

Example 2: Fourplex in Indianapolis, IN

Purchase price: $280,000. Monthly rent per unit: $950 ($45,600/year total). Annual operating expenses: $17,100 (taxes $3,400, insurance $2,800, management $4,560, maintenance $4,000, vacancy $2,340). NOI: $45,600 minus $17,100 = $28,500. Cap rate: $28,500 / $280,000 = 10.2%. A strong cap rate reflecting the lower price point and Midwest market dynamics.

Example 3: Condo in Miami, FL

Purchase price: $520,000. Monthly rent: $2,800 ($33,600/year). Annual operating expenses: $18,200 (HOA $7,200, taxes $5,200, insurance $3,600, maintenance $1,200, vacancy $1,000). NOI: $33,600 minus $18,200 = $15,400. Cap rate: $15,400 / $520,000 = 3.0%. A compressed cap rate typical of high-demand coastal markets. The high HOA fee significantly impacts NOI.

How to Use Cap Rate in Your Investment Strategy

Cap rate is best used as a starting point, not the final word. When evaluating a deal, begin with cap rate to determine if the property falls within your target range. Then move to a full cash flow analysis that factors in financing, capital expenditures, and your specific tax situation. Pair cap rate with other metrics like cash-on-cash return to understand how leverage affects your actual returns, and use DSCR to ensure the property supports its debt. Use our free cap rate calculator to run the numbers on any property in seconds.