What Is Cap Rate in Real Estate? How to Calculate It
Investors in shops, offices and rented property use one number to compare deals fast: the cap rate. It tells you the yearly return a property gives on its price, before any loan. Once you know how to read it, you can size up an investment in seconds. This guide explains what the cap rate is, how to calculate it, and how to use it wisely.
What cap rate means
Cap rate is short for capitalisation rate. It is the yearly net operating income of a property divided by its market value or price, shown as a percentage. It measures the return a property gives from its rent alone, without a loan. A higher cap rate means a higher income return for the price, and often a higher risk. A lower cap rate means a lower income return, usually for a safer, prime property.
How to calculate the cap rate
The formula is simple.
Cap rate = Net operating income / Property value × 100
Net operating income is the yearly rent minus running costs like maintenance, property tax and insurance, but before any loan payment. For example, a shop worth 1 crore that earns 8 lakh a year in net income has a cap rate of 8%. If the same shop cost 1.6 crore, the cap rate would fall to 5%.
| Property value | Net yearly income | Cap rate |
|---|---|---|
| 1 crore | 8 lakh | 8% |
| 1.6 crore | 8 lakh | 5% |
What a good cap rate looks like
There is no single right number. In India, commercial property such as offices and shops often shows cap rates of around 6% to 10%, while prime residential property shows lower cap rates of about 2% to 4%, because homes are priced for future price growth as much as rent. A prime, low-risk property in a top location will have a lower cap rate. A property in a weaker area may show a high cap rate to reward the higher risk.
Cap rate versus rental yield
Cap rate and rental yield are close. Gross rental yield uses the full rent, while cap rate uses the net income after running costs, which makes it more accurate for an investor. Both ignore the loan. Read our guide on rental yield in India to see the simpler measure, and our note on capital appreciation for the price-growth side of the return.
How to use the cap rate
- Compare similar properties fast to see which gives a better income return.
- Judge whether a price is fair for the income the property earns.
- Remember a very high cap rate can signal higher risk, a weak location, or a problem to check.
- Use it with capital appreciation and your loan cost to see the full picture.
Frequently asked questions
What is cap rate in real estate?
Cap rate, or capitalisation rate, is the yearly net operating income of a property divided by its value, shown as a percentage. It measures the income return from rent alone.
How do you calculate cap rate?
Divide the net operating income by the property value and multiply by 100. A property worth 1 crore earning 8 lakh a year has a cap rate of 8%.
What is a good cap rate in India?
There is no fixed number. Commercial property often shows 6% to 10%, while prime residential shows 2% to 4%, since homes are priced for price growth too.
What is net operating income?
It is the yearly rent minus running costs like maintenance, property tax and insurance, but before any loan payment.
Does a higher cap rate mean a better deal?
Not always. A higher cap rate gives more income for the price but often signals higher risk or a weaker location. Check why the rate is high.
What is the difference between cap rate and rental yield?
Gross rental yield uses the full rent, while cap rate uses net income after running costs. Cap rate is a more accurate measure for an investor.
Does cap rate include the home loan?
No. Cap rate ignores any loan. It measures the property's own return, so you can compare properties on the same basis.
Why do prime properties have a low cap rate?
Because they are safer and priced for future price growth, so buyers accept a lower income return for lower risk and better appreciation.
Can cap rate change over time?
Yes. As rent or the property value changes, the cap rate changes. Rising values with flat rent push the cap rate down.
Is cap rate useful for residential property?
It can be, but residential returns lean more on price growth than rent, so cap rate is lower and appreciation matters more.
How is cap rate used to value a property?
You can divide the net income by a market cap rate to estimate value. If similar properties trade at 8%, a property earning 8 lakh is worth about 1 crore.
What running costs are deducted for cap rate?
Maintenance, property tax, insurance and management costs are deducted from rent to get the net operating income, before any loan.
Is a low cap rate always bad?
No. A low cap rate can reflect a safe, prime property with strong appreciation potential. It is about matching the rate to the risk and your goal.
Should I rely only on cap rate?
No. Use it with capital appreciation, location, tenant quality and your loan cost to judge the full investment, not the income return alone.
The cap rate is a quick, honest measure of a property's income return, ideal for comparing commercial deals. Pair it with appreciation and loan cost. Explore commercial properties to put it to use.
