Real Estate Tax Calc
The formula and what it means
Cap rate = Net Operating Income (NOI) ÷ Property Value. NOI is gross rental income minus vacancy and collection loss minus all operating expenses (property taxes, insurance, management, maintenance, utilities) — before debt service. Cap rate is a financing-neutral metric: it measures how much income the property generates relative to its purchase price, ignoring how you financed it.
Example: A building with $80,000 NOI sold for $1,000,000 has an 8% cap rate. The same building generating $80,000 NOI at a 5% cap rate would be priced at $1,600,000. The formula also works in reverse: if you know the cap rate for your market and the NOI, you can estimate the property's value.
Cap rate vs. cash-on-cash return
Cap rate and cash-on-cash return look similar but measure different things. Cap rate is pre-debt (ignores your mortgage); cash-on-cash return is post-debt (measures cash flow on your actual cash invested). A property can have a 6% cap rate but a 12% cash-on-cash return if the mortgage rate is below the cap rate — this is positive leverage. If your mortgage rate exceeds the cap rate, leverage is negative and cash-on-cash will be lower than the cap rate.
Use the cap rate to compare properties in the market on an apples-to-apples basis, and cash-on-cash return to evaluate your specific return given your financing terms.
Market cap rates and what they signal
Cap rates vary by location, property type, tenant quality, and economic conditions. A lower cap rate means investors are paying more per dollar of income — signaling high demand, low perceived risk, or strong appreciation expectations. A higher cap rate means more income per dollar invested but also potentially more risk, lower demand, or a secondary market location. Cap rates and interest rates tend to move together over time; when the 10-year Treasury yield rises, cap rates often follow, putting downward pressure on property prices.
A worked example: pricing a building from its income
Say a small apartment building collects $120,000 in gross potential rent. Apply a 5% vacancy and collection allowance (−$6,000) to get $114,000 of effective gross income. Operating expenses — property taxes $18,000, insurance $6,000, management at 8% of collected rent ($9,120), repairs and maintenance $10,000, utilities and trash $8,000, and reserves $4,000 — total $55,120. NOI = $114,000 − $55,120 = $58,880. At a market cap rate of 6.5%, the implied value is $58,880 ÷ 0.065 = $905,846.
The same NOI at a 7.5% cap rate is worth only $785,067 — a roughly $120,000 swing from a single percentage point. This sensitivity is why small cap-rate movements dominate real estate values, and why buyers and sellers negotiate hard over the exact NOI and the exact cap rate applied to it.
Building NOI correctly — the number everyone gets wrong
A cap rate is only as reliable as the NOI behind it, and NOI is where broker pro formas most often mislead. A defensible NOI: (1) uses market rents and a realistic vacancy factor, not a seller's best month; (2) includes a management fee even if you self-manage, because your time has value and the next buyer will pay for it; (3) includes a capital-reserve line for roofs, HVAC, and unit turnover; and (4) excludes mortgage principal and interest, depreciation, and income taxes, which are financing and accounting items rather than property operations.
Sellers routinely inflate NOI by omitting management and reserves, or by listing 'pro forma' rents no current tenant actually pays. Always rebuild the number yourself from the actual rent roll and trailing-twelve-month operating statements before applying a cap rate.
Going-in cap rate vs. exit cap rate
The going-in cap rate is NOI ÷ purchase price at acquisition. The exit (or terminal) cap rate is the rate you assume a future buyer will pay when you sell, applied to the NOI at that time. Careful underwriting almost always assumes the exit cap is higher than the going-in cap — typically 25 to 75 basis points — because the building is older at sale and to build in conservatism. A projection that assumes cap-rate compression (a lower exit cap) is betting on market appreciation rather than on the operations you control, and deserves extra scrutiny.
What moves cap rates up and down
Cap rates respond to (1) interest rates — as Treasury yields and borrowing costs rise, investors demand higher yields, pushing cap rates up and prices down; (2) perceived risk — tenant credit, remaining lease term, deferred maintenance, and market stability; (3) growth expectations — markets with strong rent growth trade at lower cap rates because buyers pay up for future income; and (4) property class and type — trophy urban multifamily might trade at 4–5% while a rural retail strip might be 8–9%. A low cap rate is not automatically a bad deal, nor a high cap rate a good one — each reflects the risk and growth the market is currently pricing in.
Where the cap rate falls short
Cap rate is a snapshot of one year's income at one price. It says nothing about financing, appreciation, tax benefits, future capital expenditures, or the trajectory of rents — so it is a screening tool, not a complete return measure. It also breaks down for properties with little or no current income (raw land, heavy value-add, ground-up development), where there is no stabilized NOI to capitalize. For those, investors lean on IRR, cash-on-cash return, and yield-on-cost instead. Treat cap rate as the first filter, then layer on the metrics that account for leverage and time.
The property-tax reassessment trap
One cap-rate mistake is especially costly: using the seller's property-tax bill in your NOI. In many states a sale triggers reassessment to the new purchase price, so your property taxes jump the year after you buy. If you capitalize an NOI built on the old, lower tax bill, you will systematically overpay for the property. Always re-underwrite NOI using the property taxes you will pay after reassessment — estimated as your purchase price times the local millage rate — not the taxes the current owner enjoys under an older assessed value.
Yield-on-cost: the value-add cousin of cap rate
For value-add and development deals, investors track yield-on-cost (also called development yield or return-on-cost): stabilized NOI divided by total project cost, including purchase price plus renovation or construction spending. The goal is a yield-on-cost meaningfully above the market cap rate at which the finished property will trade. The spread between them — the development spread — is the value created. If you renovate to a 7.5% yield-on-cost in a market where stabilized assets sell at a 6% cap rate, that 150-basis-point spread is your profit margin, converted into equity when you refinance or sell the repositioned property.
Cap-rate compression and expansion over a cycle
Prices can rise or fall even when a property's NOI is flat, purely because market cap rates move. Compression (falling cap rates) inflates values and rewards owners who bought earlier at higher rates; expansion (rising cap rates) does the reverse and can erase equity even in a well-run building. Because cap rates broadly track interest rates, a rising-rate environment pressures values across the board. Prudent underwriting never counts on compression: assume a flat-to-higher exit cap, and make the deal work on the NOI growth and cash flow you can actually control, so any compression becomes upside rather than the entire thesis.
A rough cap-rate map by property type
As a rough orientation — actual rates move constantly with the market and cycle — stabilized multifamily in strong metros often trades in the 4.5–6% range; suburban and secondary-market apartments 6–7.5%; industrial and well-leased single-tenant net-lease properties 5.5–7%; suburban office and retail 7–9%; and hotels or specialized assets higher still to compensate for operating risk. Within any category, newer, better-located, better-tenanted properties command lower cap rates. Use these figures only as a sanity check — always anchor to recent comparable sales in the specific submarket, because a national average tells you little about one building on one street in one quarter.
Frequently asked questions
What does a lower cap rate mean?
A lower cap rate means a higher purchase price relative to income — investors are accepting a smaller yield, often because they expect appreciation or see less risk. Urban core properties in major markets typically trade at lower cap rates.
What is yield-on-cost and how does it differ from cap rate?
Yield-on-cost divides stabilized NOI by total project cost (purchase plus renovation or construction), while cap rate divides NOI by market value or price. Value-add investors aim for a yield-on-cost comfortably above the market cap rate; that spread is the value they create.
Does the cap rate include the mortgage?
No. Cap rate is calculated on net operating income before any debt service, so it is independent of how you finance the purchase. To measure the return on your actual cash after the mortgage, use cash-on-cash return instead.
Should the exit cap rate be higher or lower than the going-in cap?
Conservative underwriting assumes the exit cap rate is higher than the going-in rate — often 25 to 75 basis points — to account for the building aging and to avoid relying on market appreciation you cannot control.
Why can a seller's cap rate overstate my real return?
Because it often rests on an understated NOI: no management fee, no reserves, pro-forma rents, and the seller's old (lower) property-tax bill. Rebuild NOI with your post-reassessment taxes and realistic expenses before trusting the quoted cap rate.
Is cap rate the same as return on investment?
No. Cap rate is a pre-debt income yield on the total property value. ROI and cash-on-cash return incorporate your actual equity and financing terms.
How do I calculate NOI for a cap rate?
NOI = gross rents − vacancy − operating expenses. Do not subtract mortgage payments — cap rate is pre-debt.
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.