Cap Rate Explained
Capitalization rate — cap rate — is the most common way to compare rental properties on a like-for-like basis. It strips out financing so you can judge the property itself.
The cap rate formula
Cap Rate = Net Operating Income ÷ Purchase Price
If a property nets $18,000 a year and costs $250,000, the cap rate is 7.2%. Because it ignores your mortgage, two investors with different loans can still compare the same property fairly.
What's a good cap rate?
It depends on the market and risk. Stable, low-risk areas often trade at 4–6%; higher-risk or higher-growth markets can run 7–10%+. A higher cap rate means more income per dollar invested — but often more risk or work.
Cap rate vs cash-on-cash
Cap rate measures the property unleveraged. Cash-on-cash measures your return after financing, based on the actual cash you put in. You want both — cap rate to compare properties, cash-on-cash to judge your personal return.
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