What Is Cap Rate and How Do I Calculate It?

The cap rate formula, with an example

The cap rate formula is simple: Cap Rate = Net Operating Income / Purchase Price. For example, if a duplex generates $2,500/month in rent ($30,000/year) and has $6,000/year in operating expenses (taxes, insurance, management, maintenance), the NOI is $24,000. If the purchase price is $300,000, the cap rate is 8% ($24,000 / $300,000).

That 8% is the property's return as if it were bought in cash, before financing and before income tax. It is the fastest way to compare two properties on the same terms, which is exactly why investors reach for it first.

How to calculate NOI: rent minus expenses

Net Operating Income is your gross rental income minus all operating expenses. Expenses include property taxes, insurance, property management (8-10%), maintenance (5-10% of rent), vacancy (5-10%), HOA fees, and utilities you pay. Do not include mortgage payments; NOI is calculated before debt service.

The expense assumptions are where cap rate math gets honest or gets fudged. Underestimate vacancy and maintenance and the cap rate looks great on paper and terrible in real life. I tell investors to use the higher end of the range and let the deal surprise them in a good direction.

What cap rate tells you: return indicator, not cash flow

Cap rate is a measure of potential return, not actual cash flow. A higher cap rate suggests higher potential return but also higher risk. A lower cap rate suggests a more stable, lower-risk investment. Cap rate is most useful for comparing similar properties in the same market.

Think of it as the speedometer, not the destination. Cap rate tells you how the market prices the risk of that property, and it is only meaningful when you compare apples to apples: same market, same property type, same assumptions.

Cap rate vs cash-on-cash return

While cap rate measures return on the full purchase price, cash-on-cash return measures return on your actual cash invested. An 8% cap rate property with 25% down might give you a 12% cash-on-cash return because your investment is only the down payment, not the full price. Cap rate ignores financing, which is a limitation.

Run both numbers on every deal. Cap rate tells you how the property compares to the market, and cash-on-cash tells you how the deal compares to your money. The two together give you the full picture, and either one alone can mislead you.

How to compare properties using cap rate

When comparing properties, use cap rate as a starting point. A 6% cap rate in a stable neighborhood might be better than a 9% cap rate in a declining area. Look at cap rates for similar properties in the same area to understand what is normal for that market.

Cap rate is a filter, not a verdict. It gets you to the short list, and then the real analysis begins: condition, location, rent growth, expenses, and your own financing. The investor who compares on cap rate alone is leaving money on the table.

San Antonio market context

In the San Antonio market, residential cap rates typically range from 5-8%. Properties in established neighborhoods like Stone Oak or Alamo Heights tend to have lower cap rates (5-6%) but more stable appreciation. Properties in developing areas may have higher cap rates (7-8%) with more growth potential.

The range is a starting point, not a rule. What matters is what the number means for the specific property: the condition, the tenant pool, the expenses, and your plan. Make it a great one: use cap rate to shortlist, then dig into the deal like it owes you money.