Cap Rate Guide: Calculate, Compare & Analyze Returns

Cap rate is the single most important metric for comparing investment properties. Learn how to calculate it, interpret it, and use it to identify undervalued deals. Complete guide with formulas, benchmarks, and real examples.

What Is Cap Rate?

Cap rate (capitalization rate) measures how much annual income a property generates relative to its purchase price, independent of how you finance it. It's your most powerful tool for comparing deals fairly across different markets and property types.

Formula: Cap Rate = NOI ÷ Purchase Price

Example: $40,000 NOI ÷ $500,000 Price = 8.0% Cap Rate

(This property returns 8% annually before financing)

Why Cap Rate Is Your Most Important Metric

Compares Apples to Apples

A $300K property with 8% cap rate generates the same $24,000 annually as a $600K property with 4% cap rate. Cap rate neutralizes price differences.

Ignores Financing

Two identical properties might have different cash flows if financed differently. Cap rate shows the true earning power regardless of down payment or interest rates.

Shows Market Value

If market cap rates are 8% but this property is priced for 6%, it's overpriced. If priced for 10%, it's undervalued or has risk factors.

Predicts Returns

Higher cap rates typically predict higher annual returns (more income relative to price). Every 1% matters—an 8% property outperforms a 6% property by $20K/year on a $1M property.

How to Calculate Cap Rate (Step-by-Step)

Step 1: Calculate Gross Annual Income

• Unit 1 Rent: $1,200/month × 12 = $14,400
• Unit 2 Rent: $1,200/month × 12 = $14,400
• Unit 3 Rent: $1,300/month × 12 = $15,600

Gross Income: $44,400/year

Tip: Use 12-month averages, not projected rents. Be conservative with occupancy assumptions.

Step 2: Subtract Operating Expenses

• Property Tax: $3,600
• Insurance: $1,800
• Maintenance/Repairs: $3,000
• Property Management: $4,440 (10% of income)
• Utilities (owner-paid): $1,200
• Vacancy Reserve (5%): $2,220

Total Expenses: $16,260/year

Tip: Use historical actuals from the seller. Don't estimate—get 3 years of P&Ls.

Step 3: Calculate NOI

• Gross Income: $44,400
• Operating Expenses: -$16,260

NOI: $28,140/year

Tip: NOI excludes mortgage payments. This is income available to pay debt service or distribute as profit.

Step 4: Divide NOI by Purchase Price

• NOI: $28,140
• Purchase Price: ÷ $350,000

Cap Rate: 8.04%

Tip: This property earns 8.04% annually on your investment, independent of how you finance it.

Cap Rate Benchmarks: What's Good?

Capital Region Advantage

Capital Region properties typically offer 8.2-8.9% cap rates compared to national averages of 6-7%. This means a $300K property here returns $1,800-2,700/month MORE than the same price in most US markets. That's the power of location selection.

Common Cap Rate Questions

Can a high cap rate hide problems?

Yes. If market cap rates are 8% but this property is 12%, there's probably a reason: bad tenants, deferred maintenance, declining neighborhood, or overestimated income. Always dig deeper.

Should I refinance if rates drop?

Only if the new payment still maintains acceptable cash flow. Refinancing doesn't improve cap rate (that's fixed when you buy), but it can improve cash flow if rates drop.

Does cap rate change after you buy?

The cap rate at purchase is fixed. But your actual return changes if the property value or NOI changes. This is why market analysis and tenant management matter post-purchase.

How does appreciation affect cap rate?

Appreciation doesn't directly affect cap rate, but it affects total return. If you buy at 8% cap rate and property appreciates 4%/year, your total return is 12%/year (8% income + 4% appreciation).

Why Capital Region Cap Rates Are Higher

Capital Region multifamily typically trades at 8.2-8.9% cap rates because:

• Entry prices are lower ($250K-$310K vs $400K+ nationally)
• Rents are solid ($1,400-$1,800 for 2BR)
• Expense ratios are favorable (taxes reasonable compared to some northeast markets)
• Tenant quality is high (government workers, healthcare professionals, students)
• Markets are less saturated with institutional investors driving down cap rates

This creates inefficiency—the opportunity to buy solid properties at higher yields than coastal markets.

How to Use Cap Rate in Deal Evaluation

Never buy below your target cap rate

If you need 8% cap rate to meet your investment goals, don't buy a 7% property expecting to "add value." You're competing against better deals in the same market.

Compare properties in the same market

A 7% property in Albany vs an 8% property in Troy aren't directly comparable. Use cap rate to compare similar neighborhoods in the same market.

Stack cap rate + appreciation for total return

Don't choose between cap rate and appreciation. Look for markets with both. Troy and Schenectady both offer 7.5-8.9% cap rates AND 5-9% annual appreciation.

Use cap rate to identify overpriced properties

If market is 8% and a comparable property is listed for 6%, it's likely overpriced or has hidden issues. Walk away unless you understand the reason for the discount.

Your Next Step

Now that you understand cap rates, find 5 recent listings in your target neighborhood (Albany, Schenectady, or Troy). Calculate their cap rates using the framework above. Compare to market averages. Identify which properties offer value. Ready to analyze specific properties with professional insight? Let's run numbers on deals in your target market and find opportunities that match your return targets.