Question 1

What is cap rate in real estate?

Accepted Answer

Cap rate (capitalization rate) is the ratio of a property’s net operating income (NOI) to its value. It is calculated as (Annual NOI ÷ Property Value) × 100. Cap rate is financing-agnostic, it tells you what the property would yield if owned free and clear.

Question 2

What is a good cap rate?

Accepted Answer

Cap rates vary by market, asset class, and risk. Coastal metro A-class can run 3–5%, Midwest B-class typically 6–8%, and C-class or rural can be 9%+. A higher cap rate is not inherently better, it often reflects higher risk (older properties, weaker tenant base, less appreciation).

Question 3

Does cap rate include my mortgage?

Accepted Answer

No. Cap rate uses NOI, which is income minus operating expenses, it does not subtract the mortgage payment. That is what makes cap rate useful for comparing properties across different financing structures. Cash-on-cash return is the metric that includes your mortgage.

Question 4

What is NOI?

Accepted Answer

Net Operating Income = Effective Gross Income (rent × (1 − vacancy%)) minus operating expenses (taxes, insurance, HOA, property management, maintenance, CapEx reserve). It’s the property’s income before financing costs and taxes.

Question 5

Cap rate vs cash-on-cash, which is better?

Accepted Answer

They measure different things. Cap rate lets you compare two properties apples-to-apples regardless of financing. Cash-on-cash tells you what your cash investment is actually earning. Use both: cap rate to compare deals, cash-on-cash to compare against other uses of your capital.

Question 6

What is cap rate compression?

Accepted Answer

When prices rise faster than rents, cap rates fall, buyers are willing to accept a lower yield per dollar. This is called cap rate compression. The opposite (cap rate expansion) happens when interest rates rise and values fall faster than rents adjust.

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