What does NOI include and exclude?

NOI is gross rental income minus all operating expenses: property taxes, insurance, property management, maintenance, and vacancy allowance. It excludes mortgage payments (principal and interest), capital expenditures, depreciation, and income taxes — those are financing or accounting items, not operating costs.

What is a good cap rate?

There is no universal 'good' cap rate. In high-cost coastal markets, 4–5% may be typical; in Midwest or Sun Belt secondary markets, 6–8% is common. A cap rate should be read against local market norms, property class, and the investor's risk tolerance. A higher cap rate often signals higher vacancy risk or deferred maintenance.

How is cap rate different from cash-on-cash return?

Cap rate ignores financing — it treats the property as if paid in cash. Cash-on-cash return factors in your actual mortgage, measuring annual pre-tax cash flow against the cash you put in. Two identical properties at the same cap rate can have very different cash-on-cash returns depending on the loan terms.

What are the limitations of cap rate?

Cap rate is a snapshot, not a forecast. It doesn't reflect future rent growth, capital expenditure needs, or financing costs. A low cap rate in a high-appreciation market may still be a sound investment; a high cap rate in a declining market may not. Always pair it with a full cash-flow analysis.

Cap rate, explained

The cap rate formula

Cap rate = NOI ÷ Current market value (or purchase price)

If a property generates $18,000 in Net Operating Income and you buy it for $300,000, the cap rate is 6%.

The formula works in both directions. You can use a known cap rate to estimate value: if comparable properties trade at a 6% cap and your target property produces $18,000 NOI, the implied value is $300,000. This is how commercial appraisers use it.

What goes into NOI

NOI is gross rent minus operating expenses. It is not what lands in your bank account after the mortgage.

Included in operating expenses:

Property taxes
Landlord insurance
Property management fees (typically 8–10% of gross rent)
Routine maintenance and repairs
Vacancy allowance (a realistic estimate, not zero)
HOA dues where applicable

Excluded from NOI:

Mortgage principal and interest
Capital expenditures (new roof, HVAC replacement)
Depreciation
Income taxes

Leaving out the mortgage is deliberate. Cap rate compares properties independent of financing, so two buyers with very different loans still judge the same building on the same footing.

What cap rate range is “good”?

Market type	Typical cap rate range
High-cost coastal (NYC, LA, SF)	3–5%
Major metros (Chicago, Dallas, Atlanta)	5–7%
Secondary and tertiary markets	6–9%+
Distressed or high-vacancy assets	8–12%+

A 5% cap rate in Boston and a 5% cap rate in Memphis are not equivalent. The Boston property likely carries lower vacancy risk, more stable tenant demand, and more liquidity. The Memphis property may be priced lower in nominal terms but demands more management and carries higher default risk. Out-of-state buyers chase the higher headline cap rate and get burned on the vacancy and management they never priced in.

Cap rate vs. cash-on-cash return

Cap rate answers: “What does this property yield if I own it free and clear?”

Cash-on-cash return answers: “What does this property yield on the actual cash I put in, given my specific loan?”

Example: a $300,000 property with $18,000 NOI has a 6% cap rate for every buyer. But a buyer who puts $75,000 down and takes a 30-year mortgage at 7% might generate only $4,200 in annual cash flow after debt service — a cash-on-cash return of 5.6%. A buyer who puts $150,000 down might see $9,000 in annual cash flow — a cash-on-cash of 6.0%. Same cap rate, different returns.

When leverage is your primary consideration, cash-on-cash is the more relevant metric. Cap rate matters most when comparing properties at the asset level — before financing decisions.

When cap rate misleads you

Cap rate is a single-year, income-only metric. It doesn’t capture:

Rent growth potential over time
Deferred capital expenditures hiding in the P&L
Local supply and demand trends
A property’s age, condition, or tenant quality

A 7% cap rate on a 1965 fourplex with 20-year-old mechanicals may look better than a 5.5% cap rate on a new-construction duplex, but the older property likely requires $30,000 in near-term capex that the cap rate calculation never showed you.

Treat cap rate as a first filter and nothing more. The fourplex example above hid $30,000 of near-term capex behind a clean number. Build the real cash flow and a capex reserve before you anchor to a price.