Key takeaways
- Cap rate = NOI ÷ value. Value = NOI ÷ cap rate. Only one number in that equation is ever real. Know which one.
- A quoted cap rate is only as good as the NOI behind it. Rebuild NOI from trailing actuals before you trust the rate.
- On $100,000 of NOI, the gap between a 7% and an 8% cap rate is $178,571 of value.
- In Florida, a sale resets the assessed value of non-homestead property. The buyer's property tax bill, and NOI, can change after closing.
The formula
The capitalization rate expresses a property's net operating income (NOI) as a percentage of its value or price.
Cap rate = Net operating income ÷ Value
Value = Net operating income ÷ Cap rate
A building producing $84,000 of NOI and priced at $1,200,000 is trading at a 7.0% cap rate ($84,000 ÷ $1,200,000). Run it the other way: if similar buildings trade around 7.0%, $84,000 of NOI implies a value near $1.2 million.
Cap rate is measured before debt. It says nothing about the mortgage, and nothing about what happens after year one.
Why cap rates are circular
A cap rate describes a relationship between two numbers. If you know the NOI and the price, you know the cap rate. If you know the NOI and pick a cap rate, you've picked the price.
That's where cap rates get misused. A seller's pro forma NOI divided by a "market" cap rate produces a value built on two estimates. The math is clean. The inputs aren't.
NOI divided by cap rate equals value. NOI divided by value equals cap rate. Only one number is real. Know which one.
In a closed sale, the price is real. In a listing, the NOI might be real, if it comes from trailing statements. A cap rate quoted in a marketing package is usually the output of someone else's assumptions.
Where the NOI goes wrong
Most cap-rate errors are NOI errors. The common ones:
- Pro forma rent on vacant space, or market rent assumed on below-market leases.
- No vacancy or credit loss, even on a multi-tenant property.
- No management fee because the owner self-manages. A buyer will pay someone, or pay with their time.
- No reserves for roofs, HVAC, and parking lots.
- Property taxes at the seller's assessed value. In Florida, the 10% annual cap on assessment increases for non-homestead property ends at a change of ownership, and the property is reassessed at just value as of the next January 1 (s. 193.1555, Florida Statutes).
The same property, underwritten two ways:
| Line item | Seller's statement | Underwritten |
|---|---|---|
| Gross potential rent | $150,000 | $150,000 |
| Vacancy and credit loss (5%) | $0 | ($7,500) |
| Effective gross income | $150,000 | $142,500 |
| Property taxes | ($18,000) | ($24,000) reassessed after sale |
| Insurance | ($12,000) | ($15,000) |
| Repairs and maintenance | ($9,000) | ($9,000) |
| Management (5% of EGI) | $0 | ($7,125) |
| Reserves | $0 | ($4,500) |
| Net operating income | $111,000 | $82,875 |
| Value at a 7.5% cap rate | $1,480,000 | $1,105,000 |
Illustrative example. Hypothetical numbers chosen to show the math. Your property's numbers will differ.
Same building, same cap rate, $375,000 apart. The cap rate didn't change. The NOI did.
Small rate changes, big value changes
Because value divides by the cap rate, small moves in the rate swing value hard. On $100,000 of NOI:
| Cap rate | Implied value | Change vs. 7.0% |
|---|---|---|
| 6.0% | $1,666,667 | +$238,095 |
| 6.5% | $1,538,462 | +$109,890 |
| 7.0% | $1,428,571 | n/a |
| 7.5% | $1,333,333 | ($95,238) |
| 8.0% | $1,250,000 | ($178,571) |
| 8.5% | $1,176,471 | ($252,101) |
Illustrative example. Hypothetical numbers chosen to show the math. Your property's numbers will differ.
Half a point of cap rate on a $1.4 million building is roughly $100,000. That's why the exit cap rate in a hold-period analysis deserves as much scrutiny as the going-in rate.
How to test a quoted cap rate
- Get the trailing 12 months of income and expenses and the current rent roll. Compare them to each other.
- Rebuild NOI with vacancy, management, reserves, and the property tax bill a buyer will actually pay.
- Read the leases. Confirm who pays taxes, insurance, and maintenance, and when each lease expires.
- Ask whether the rate is in-place or pro forma. A cap rate on projected rent is a forecast.
- Check price per square foot against recent sales and replacement cost. A cap rate can look fine while the price per foot doesn't.
- Look at what the income rests on. One tenant with two years left is a different asset than five tenants with staggered terms, at the same cap rate.
What to use alongside it
Cap rate is a one-year, unlevered snapshot. Pair it with:
- DSCR and debt yield, to see whether the income supports the loan.
- Cash-on-cash, IRR, and equity multiple, to see the return on your actual equity over the hold.
- Price per square foot and replacement cost, to check the basis.
Common questions
What is a good cap rate for commercial property?
There isn't one number. Cap rates vary by property type, location, tenant credit, lease term, and interest rates. A higher cap rate means more income per dollar of price, usually with more risk. Compare a property to recent sales of similar properties in the same submarket, after rebuilding the NOI.
Does the cap rate include the mortgage payment?
No. Cap rate uses net operating income, which is calculated before debt service. Financing shows up in DSCR, debt yield, and cash-on-cash return.
Is cap rate the same as return on investment?
No. Cap rate is a single-year, unlevered ratio of NOI to price. Your actual return depends on financing, capital spending, rent growth, and the price you sell for.
Why does Florida property tax matter for cap rate?
Florida caps annual assessment increases on non-homestead property at 10% (excluding school taxes), but the cap resets at a change of ownership. A buyer's tax bill can be higher than the seller's, which lowers NOI and the real cap rate.
Sources
Sources retrieved October 2, 2026.
General information, not legal, tax, accounting, or investment advice. Examples marked illustrative use hypothetical numbers.