| Detail | Explanation |
|---|---|
| Formula | Net operating income divided by value |
| Solves for value | Net operating income divided by cap rate |
| Lower cap rate | Higher price for the same income |
| Ignores | Financing, income growth, and capital spending |
How do you calculate a cap rate?
Use a full year of net operating income and the purchase price or appraised value. Any 2 of the 3 inputs solve the third, which is why brokers quote cap rates when pricing income property and appraisers use them in the income approach. The cap rate calculator runs either direction.
Cap rate = net operating income / value, and value = net operating income / cap rate
Worked example
In this hypothetical example, a property with $650,000 of net operating income sells for $10,000,000, a 6.50% cap rate. The table shows what happens to value and to a loan sized at 65% loan-to-value when the market cap rate moves.
| Cap rate | Value | Loan at 65% of value |
|---|---|---|
| 6.00% | $10,833,333 | $7,041,667 |
| 6.50% | $10,000,000 | $6,500,000 |
| 7.00% | $9,285,714 | $6,035,714 |
Why cap rates matter for financing
When cap rates rise, identical income is worth less. In the hypothetical, a move from 6.50% to 7.00% cuts value by $714,286 and shrinks the 65% loan-to-value loan by $464,286. That is how an owner with growing rent can still face a smaller refinance than expected.
Cap rates also show whether debt helps or hurts returns. A 7.00% loan on a 30-year amortization carries a loan constant, meaning annual payments as a share of the loan, of about 7.98%. When the property yields 6.50% and the debt costs 7.98% a year, each borrowed dollar costs more than it earns, which is negative leverage. Lenders see the same math through DSCR, which is why low cap rate properties often hit coverage limits before they reach maximum leverage.
What is a good cap rate?
No single cap rate is good. A lower cap rate signals that buyers accept a lower initial yield, usually for stronger tenants, longer leases, better locations, or expected growth. A higher cap rate compensates for more risk, shorter leases, older buildings, or weaker markets. The useful comparison is against recent sales of similar property in the same submarket and against the current cost of debt.
If a cap rate shift has changed what your refinance can produce, submit the property and Capital Partners will review the options.
Cap rate limits to keep in mind
- It reflects a single year of income and says nothing about lease rollover or growth
- Sellers may quote a cap rate on pro forma income rather than in-place income
- It excludes capital needs, so 2 buildings with the same cap rate can require very different reinvestment
- Appraisers select cap rates from comparable sales, so thin sales data widens the range of possible values
Common questions
Is a higher cap rate better?
It depends on the goal. A buyer gets more initial income per dollar at a higher cap rate but usually takes on more risk. For a borrower, a higher cap rate means a lower appraised value for the same income, which limits loan proceeds.
How do lenders use the cap rate?
The appraisal's income approach divides net operating income by a market cap rate to estimate value. The lender then applies its loan-to-value limit to that value.
Does the interest rate affect cap rates?
Rates and cap rates are related but do not move one for one. Higher borrowing costs tend to push buyers toward higher cap rates, since a cap rate below the loan constant produces negative leverage.
What is the difference between cap rate and debt yield?
Both divide net operating income by a dollar amount. Cap rate uses the property value. Debt yield uses the loan amount and measures the lender's position.
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