Cap Rate.

In plain English

Cap rate, short for capitalization rate, measures a rental property's annual return as if you paid all cash. You take the net operating income (yearly rent minus operating expenses like taxes, insurance, and upkeep, but not the mortgage) and divide it by the property's value or purchase price. The result is a percentage that lets you compare different properties on the same footing. A higher cap rate generally signals more income relative to price, though often more risk.

01Why it matters

It is the quickest gut-check on whether a rental's income justifies its price before you fall in love with the property or the loan terms.

02The math, step by step

A property costs 300,000 dollars and brings in 30,000 dollars of rent a year. After 12,000 dollars of operating expenses (taxes, insurance, maintenance, management), the net operating income is 18,000 dollars. Divide 18,000 by 300,000 and you get a 6 percent cap rate. The mortgage is deliberately left out so you can compare properties regardless of how each is financed.

Illustrative example. The amounts here are hypothetical, chosen to show how the math works, not real quoted rates or figures.

03What this is NOT