Cap rate is a quick way to estimate how a rental property performs based on income vs price. For residential investors—single family homes, duplexes, or small multis—it’s one of the fastest ways to compare options without digging into mortgage math yet. It gives you a snapshot of income potential today, not your long-term profit after financing.
While cap rate doesn’t replace full investment analysis, it cuts through the noise early and shows which homes deserve a deeper look.
The cap rate formula (no friction)
Cap Rate (%) = (Net Operating Income ÷ Property Value) × 100
Two main numbers drive it:
Net Operating Income (NOI): annual rent minus expenses you pay as the owner
(taxes, insurance, repairs, maintenance, property management, utilities you cover)
Property Value: what the home would likely sell for today
Cap rate ignores:
Mortgage payments
Interest costs
Down payments
It’s a cash-purchase calculation by design so every property gets the same playing field.
A clean example
You’re looking at a duplex listed at $400,000.
Annual rent collected: $38,400
Annual expenses you cover: $11,900
Step 1 — find NOI
$38,400 − $11,900 = $26,500 (NOI)Step 2 — calculate cap rate
($26,500 ÷ $400,000) × 100 = 6.62% cap rateA 6.62% cap rate means the property returns 6.62% per year before mortgage costs.
One more example with higher operating costs
A single-family rental priced at $310,000:
Annual rent: $27,600
Expenses (insurance, tax, maintenance, vacancy estimate): $9,800
$27,600 − $9,800 = $17,800 NOI ($17,800 ÷ $310,000) × 100 = 5.74% cap rate
Even though the rent looks decent, higher ownership costs push the cap rate down.
What this tells residential investors fast
Cap rate lets you:
Compare different homes with different price tags
Spot properties that are priced high for their rent potential
Benchmark the local rental market
Filter listings before you analyze financing
If you’re reviewing three similar homes in one town, cap rate helps you see which one generates more income for the price.
Why cap rate shifts around
Residential cap rates move based on three buckets:
1.
Rent levels
Low rent = lower cap rate
Rent reset to market = higher cap rate
A long-term tenant paying below-market rent can hide a property’s real potential until turnover.
2.
Operating costs
High insurance, aging systems, or frequent repairs shrink NOI, and shrink cap rate with it.
Updates like heat pumps, wiring, windows, or roof replacements can reduce ongoing costs and push NOI back up over time.
3.
Market pricing
If home prices jump faster than rents, cap rates fall.
If rents rise faster than property values, cap rates climb.
Neither situation is “good” or “bad,” but both tell you what kind of opportunity you’re buying into.
Cap rate ranges for residential rentals (general sense, not rules)
4–6% → Lower income, stable areas, slower payback
6–8% → Middle ground most small investors aim for
9%+ → Higher income potential, often more hands-on ownership
A higher cap rate can mean better income, but also higher tenant turnover, older properties, heavier maintenance, or softer demand. The number tells a story—not the full story.
Cap rate vs ROI (they aren’t twins)
Cap rate ranks the property. ROI ranks your investment after financing.
The short version
Cap rate shows a rental’s income potential today
It helps you compare homes fast
It doesn’t include mortgage costs
It works best when comparing similar rentals in the same market
If you’re looking to start or grow your real estate investment portfolio a quick cap rate review is a smart place to begin. I can help you run the numbers, compare rental options and pinpoint properties that match your goals. Reach out and we’ll start turning listings into prospects we can measure fast!
Patti Steele
(506) 962-4773
patti@pattisteele.ca
