Cap rate is the most-used screening metric in rental property investing. Here is the formula and the math behind it.
Cap Rate = NOI / Property Price × 100
Where NOI (Net Operating Income) is:
NOI = Gross Rent − Operating Expenses
Operating expenses include:
Property tax
Insurance
Vacancy allowance (5-8% of gross rent)
Maintenance (8-10% of gross rent)
Property management (8-10% of gross rent)
CapEx reserves (3-5% of gross rent)
Operating expenses do NOT include:
Mortgage payment (that's debt service, not an operating expense)
Depreciation (non-cash)
Capital improvements (one-time, not recurring)
Income tax
Worked example
Property: 3-bed SFR, Cleveland Heights, OH
Purchase price: $150,000
Monthly rent: $1,250
Annual gross rent: $15,000
Operating expenses:
Property tax: $2,100 (1.4% of value)
Insurance: $2,100 (Ohio average)
Vacancy (7%): $1,050
Maintenance (8%): $1,200
Management (10%): $1,500
CapEx (5%): $750
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Total expenses: $8,700
NOI = $15,000 − $8,700 = $6,300
Cap Rate = $6,300 / $150,000 × 100 = 4.2%
Wait — 4.2%? That seems low for Cleveland. And it is. When you include all real expenses at realistic percentages, cap rates are lower than most online calculators show.
The "6-8% cap rate" numbers you see quoted for Midwest markets typically use:
- 5% vacancy instead of 7%
- 5% maintenance instead of 8%
- 0% management (assumes self-manage)
- 0% CapEx reserves
Same property, aggressive assumptions:
Vacancy (5%): $750
Maintenance (5%): $750
Management (0%): $0
CapEx (0%): $0
Total expenses: $5,600
NOI = $15,000 − $5,600 = $9,400
Cap Rate = $9,400 / $150,000 × 100 = 6.3%
The difference: 4.2% vs 6.3%. Same property. Different assumptions. This is why cap rate comparisons between markets are only meaningful if the expense assumptions are consistent.
Cap rate benchmarks by market type (2026)
Market Type Cap Rate Example Cities
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Cash flow (Midwest) 5.5-8.0% Cleveland, Indianapolis, Memphis
Balanced 4.0-5.5% Houston, Greensboro, Columbus
Appreciation (Sun Belt) 2.5-4.0% Charlotte, Austin, Phoenix
Coastal/Gateway 1.5-3.0% San Francisco, San Diego, NYC
What cap rate does NOT tell you
- Financing impact — a 7% cap rate with a 7% mortgage = breakeven cash flow
- Appreciation potential — a 3% cap rate market may outperform on total ROI
- Tenant quality — low cap rate markets often have more stable tenants
- Maintenance trajectory — older buildings depreciate faster
- Tax benefits — depreciation, 1031 exchanges, cost segregation
Cap rate is a screening tool, not a decision tool. Use it to filter deals, then run a full analysis with cash flow, ROI, and DSCR before making an offer.
