Ask ten investors what a good cap rate is and you'll get ten answers, because the honest one is: it depends. Cap rate is a ratio, not a verdict — it's most useful for comparing similar properties in the same market, and most misleading when you rip it out of context.
What cap rate actually measures
Cap rate is annual net operating income divided by price. A property with $24,000 of NOI selling for $300,000 has an 8% cap rate. Because NOI excludes the mortgage, cap rate describes the property's own earning power, independent of how you finance it. That's its superpower and its limit: it says nothing about your loan, your taxes, or appreciation.
Higher isn't automatically better
A high cap rate usually means one of two things: the market prices that area for more risk, or the property needs work the seller has priced in. Tertiary markets, older buildings, and management-intensive properties tend to trade at higher caps. Prime, stable, high-demand areas trade lower because buyers accept less current income in exchange for safety and expected appreciation.
So a 9% cap in a declining neighborhood can be a worse investment than a 5% cap in a growing one. The number only means something next to the risk behind it.
How to use it well
- Compare like with like: same city, similar asset class and condition.
- Verify the NOI. Sellers love to quote cap rates on optimistic expenses — pin down real taxes, insurance, and a vacancy reserve first.
- Use it to shortlist, not to decide. Once a property clears your cap-rate screen, move to cash flow and cash-on-cash to see what you actually take home.
A rough frame of reference
As a very general guide, many US residential rentals trade somewhere in the 4% to 10% range depending on market and condition — but treat any benchmark with suspicion until you've checked it against comparable sales in that specific area. The right cap rate for you is the one that fairly compensates you for the risk and work of that particular deal.