How to Calculate a Cap Rate
The capitalization rate is the single most important metric in commercial real estate. It expresses the relationship between a property’s income and its price as a percentage, letting you compare deals of wildly different sizes on equal footing. The formula is deceptively simple: divide the Net Operating Income by the property value, then multiply by 100. A building that nets $70,000 per year and is worth $1,000,000 carries a 7% cap rate.
Because the relationship is a simple ratio, you can rearrange it to answer three different questions, which is exactly what the three modes above let you do. Enter income and value to find the cap rate. Enter your target cap rate and the income to find the property value the market would support. Or enter the value and your target cap rate to find the NOI the property must generate to justify the price.
Net Operating Income: The Foundation
Every cap rate calculation rests on an accurate NOI. Net Operating Income is the property’s annual income after operating expenses but before debt service and income taxes. Start from gross potential income — all the rent and ancillary income the property could collect at full occupancy. Subtract a realistic vacancy and credit-loss allowance to arrive at effective gross income, then deduct operating expenses: property taxes, insurance, utilities, repairs and maintenance, property management, and replacement reserves.
What you deliberately leave out of NOI matters just as much as what you include. Mortgage payments, depreciation, capital improvements, and income tax are all excluded, because NOI is meant to describe how the asset performs on its own, independent of how a particular buyer finances or accounts for it. This is why two investors looking at the same building will compute the same NOI even if one pays cash and the other borrows 75% of the price.
Using Cap Rate to Value Commercial Property
The income approach to valuation is built directly on the cap rate. Rearranging the formula gives Value = NOI / Cap Rate. If brokers tell you that stabilized assets in your submarket trade at a 6.5% cap and your target building produces $130,000 of NOI, the implied value is roughly $2,000,000. Appraisers, lenders, and acquisitions teams all lean on this relationship, which is why the "Find Property Value" mode mirrors how professional valuations are actually constructed.
The scenario table beneath the result drives home how sensitive value is to the cap rate the market applies. Holding NOI constant, a property worth $1,000,000 at a 7% cap is worth roughly $1,400,000 at a 5% cap and only about $700,000 at a 10% cap. This is "cap rate compression and expansion" in action: when capital is cheap and demand is high, cap rates compress and values rise; when interest rates climb and risk appetite falls, cap rates expand and values fall — even if the property’s income never changes.
Reading the Supporting Metrics
The calculator surfaces several companion figures that sharpen your analysis. The expense ratio — operating expenses divided by gross income — tells you how efficiently the property runs; well-managed assets often land between 35% and 50%, and a ratio far outside that range deserves scrutiny. The Gross Rent Multiplier (GRM), value divided by gross income, is a fast screening ratio that ignores expenses, useful for triaging a long list of listings before you commit to a full underwriting pass.
Treat these numbers as a system rather than in isolation. A tempting 9% cap rate paired with a 65% expense ratio may signal deferred maintenance, an aging building, or optimistic income assumptions that will not survive due diligence. Conversely, a modest 5% cap on a property with a lean expense ratio and durable tenancy can be the safer long-term hold. Always pressure-test the underlying NOI — stretch the vacancy assumption, verify tax and insurance figures, and confirm that reserves are funded — before trusting any cap rate the spreadsheet returns.
Cap Rate, Leverage, and the Real Return
Cap rate intentionally ignores financing, so it is not the return you actually pocket once a loan is involved. When the cap rate exceeds your borrowing cost, leverage is positive and your cash-on-cash return climbs above the cap rate; when debt is more expensive than the cap rate, leverage works against you. This is why disciplined commercial investors evaluate the unleveraged cap rate first to judge the asset itself, then layer in financing to understand the levered return — and why a rising-rate environment can turn a once-attractive cap rate into a money-losing deal.