What Is a Good Cap Rate for Rental Property?

Ask this in any investor forum and you will get numbers thrown back at you: 8%. No, 6%. In my market, anything under 10% is a pass.

All of those answers are useless without context, and most of them are quietly comparing different things. A 7% cap rate on a 1960s duplex in a declining submarket and a 7% cap rate on a five-year-old building in a growing metro are not the same investment. They are the same number describing two very different risk profiles.

Here is how to think about it properly.

The formula, and the part people get wrong

Cap Rate = Net Operating Income (NOI) ÷ Property Value

That is the whole formula. The trouble is almost never the division — it is what goes into the numerator.

NOI is income after operating expenses but before debt service, depreciation, and capital expenditures. If you include your mortgage payment, you have not calculated a cap rate. You have calculated something that changes every time you change your down payment, which defeats the entire purpose.

That is the point of cap rate: it describes the property, not your financing. Two investors buying the same building at the same price get the same cap rate, whether one pays cash and the other borrows 75%. What differs between them is their cash-on-cash return — a different metric that answers a different question.

If you are not confident your NOI is clean, start with how to calculate NOI properly. Most bad cap rate math traces back to a bad NOI.

Why “good” depends on four things

1. What the risk-free rate is doing

Cap rates do not exist in isolation. They sit at a spread above the 10-year Treasury yield, because that is the return you could get without owning a roof.

When the 10-year sits at 4%, a 5% cap rate is a 100 basis point spread for taking on tenants, vacancy, maintenance, and illiquidity. That is thin. When the 10-year was at 1.5%, that same 5% cap rate was a 350 bp spread and looked generous.

This is the single most common blind spot in retail real estate analysis. Investors memorize a target cap rate from whenever they started investing and keep applying it after the rate environment moved underneath them. Check where the 10-year is today before you decide what cap rate you require.

2. Asset class and vintage

Newer, larger, and more institutional generally trades at a lower cap rate. This is not irrational — it reflects genuinely lower capital expenditure risk and easier financing.

A 2019-built apartment building has a roof, HVAC, and plumbing with decades of life left. A 1955 fourplex has a capital event coming whether or not it appears in the seller’s pro forma. The lower cap rate on the newer building is the market pricing that difference. You are not “overpaying” for a low cap; you are buying a smaller pile of deferred capex.

3. Market trajectory

A cap rate is a snapshot of today’s income against today’s price. It says nothing about growth.

A 4.5% cap rate in a market with 5% annual rent growth will outperform a 7.5% cap rate in a market with flat rents and shrinking population, over a long enough hold. The high cap rate in the second market is not free money — it is the market’s price for a shrinking income stream and a hard exit.

The trap runs in both directions. Investors chase high caps into markets that deserve them, and investors accept very low caps on the assumption that growth will bail them out. Both are underwriting a story instead of a property.

4. How the NOI was constructed

Two brokers can present the same building at cap rates 150 basis points apart, legally, just by choosing different assumptions.

Watch for:

• Vacancy at 0%. No property runs at 100% occupancy forever. Underwrite 5–8% depending on the market, more for short-term rentals.
• No management fee. If you self-manage, you are working for free, and the moment you stop, the NOI drops. Underwrite 8–10% of gross rent even if you intend to manage yourself. Otherwise you have capitalized your own unpaid labor into the purchase price.
• No capital reserve. More on this below, because it is the big one.
• Property tax at the seller’s basis. In states that reassess on transfer — California, Florida, and Texas among others — your tax bill will not be the seller’s tax bill. Using the current tax line for a property that is about to be reassessed can overstate NOI badly.

A worked example

A four-unit building listed at $600,000, each unit renting for $1,400/month.

The broker’s version:

Nine percent. Looks strong.

The version an underwriter would run:

Same building, same rent, same price. Two full percentage points of difference, and nothing in the second column is aggressive — it is a standard institutional underwrite. The 9.1% was never real; it was gross rent wearing a cap rate costume.

This is the actual skill in real estate analysis. Not finding a magic threshold, but constructing an NOI that will still be true in year three.

So what number should you require?

The honest framing is a spread, not an absolute.

Start with the current 10-year Treasury. Then add compensation for what you are actually taking on:

If the 10-year is at 4.2% and you are buying a well-located 1980s fourplex in a stable market, something in the range of 6.5–7.5% is a defensible requirement. If the same building sits in a market losing population, you should want considerably more, and you should ask yourself whether you want it at all.

What you should not do is carry a fixed number across years and markets. “I only buy at 8%” is a heuristic that will make you pass on good deals in strong markets and load up on bad ones in weak markets — which is, unfortunately, exactly the pattern it tends to produce.

Cap rate is a screen, not a decision

Cap rate tells you what the property yields unlevered, today. It does not tell you:

• what you will actually earn on the cash you put in — that is cash-on-cash return
• what the deal returns over a full hold including sale — that is IRR
• whether the rent is achievable — that requires comps, not math

Use cap rate to compare properties against each other and against the market. Use the other metrics to decide whether to actually buy.

Running this without a spreadsheet

The underwrite above takes about fifteen minutes in Excel per property, and you will build it from scratch every time unless you are disciplined about templates. Once you are screening more than a handful of deals, that is the friction that quietly stops people from analyzing carefully — they run the broker’s numbers because running their own is tedious.

That is the actual argument for deal analysis software, and we compared the main options in best real estate deal analysis software for buy-and-hold investors.

FAQ

Is a higher cap rate always better? No. A higher cap rate means the market is demanding more yield, which usually means it perceives more risk — older asset, weaker market, less certain income. Sometimes the market is wrong and you have found value. More often it is right.

What is a good cap rate for a single-family rental? Single-family homes typically trade at lower cap rates than small multifamily, because a meaningful share of buyers are owner-occupiers who do not price on yield at all. In many metros, a single-family rental producing a 5% cap rate is competing against owner-occupant demand that will pay more than any investor’s numbers justify.

Should I use purchase price or market value in the denominator? Purchase price when evaluating a specific acquisition. Current market value when measuring how an asset you already own is performing — otherwise your cap rate on a property you bought a decade ago will look spectacular and tell you nothing about whether to keep holding it.

Does cap rate include the mortgage? No. If your calculation includes debt service, it is not a cap rate.