How to Calculate a Cap Rate
To calculate a commercial real estate cap rate, divide the property's annual net operating income (NOI) by its purchase price, then multiply by 100 to express as a percentage.
Before you start
The capitalization rate (cap rate) is the single most-used CRE metric for quick valuation and comparison. It's the unlevered year-one yield on a property at a given price. The math is trivial — the judgment is in verifying the NOI that goes into the numerator.
What you need
- Property's annual income statement or T-12
- Purchase price or asking price
- Basic calculator
Steps
- Step 01
Calculate net operating income (NOI)
Start with gross potential rent, subtract vacancy and concessions, add other income (parking, fees, laundry), then subtract all operating expenses (property taxes, insurance, utilities, repairs, management, reserves) to get NOI. Do NOT subtract debt service, depreciation, or income taxes.
- Step 02
Confirm the purchase price
Use the agreed contract price (if under contract) or the asking price (if pre-LOI). Exclude closing costs, capex reserves, and transaction fees — cap rate is calculated on purchase price of the real estate itself.
- Step 03
Divide NOI by purchase price
NOI ÷ Purchase Price = Cap Rate (in decimal). Multiply by 100 to express as a percentage.
- Step 04
Compare against market comparables
A cap rate in isolation is meaningless — compare it to recent sales of similar properties in the same submarket. A 6.67% cap may be aggressive in a market trading at 5.75%, or conservative in one trading at 7.5%.
- Step 05
Stress-test the underlying NOI
Before trusting the cap rate, sanity-check the NOI inputs: Is management fee included at 3-5%? Are replacement reserves included at $200-350 per unit (multifamily) or $0.50+ per SF (commercial)? Is property tax at post-sale reassessed levels?
Common mistakes
- Using pro forma NOI as if it were current NOI
- Subtracting debt service (that's cash-on-cash, not cap rate)
- Forgetting to adjust property taxes for post-transfer reassessment
- Comparing cap rates across different asset classes or markets without context
- Treating cap rate as a total return metric (it ignores appreciation, tax benefits, and leverage)
Frequently asked questions
What is a good cap rate for commercial real estate?
There is no universal 'good' cap rate. In 2026, institutional multifamily trades at 4.5-5.5%, credit-tenant absolute NNN at 5.5-6.5%, and value-add Class B multifamily at 6-7%+. Compare within asset class and submarket.
Does cap rate include debt service?
No. Cap rate is unlevered — NOI ÷ Price. Debt service affects cash-on-cash return, not cap rate.
Why do sellers quote a cap rate that doesn't match what I calculate?
Seller pro forma cap rates often reflect projected stabilized NOI rather than current T-12. Always compute cap rate against actuals before relying on the number.