Cap rate calculator:
compare income properties on one number

What a cap rate is

The capitalisation rate, or cap rate, is the annual income a property produces before any loan payments, divided by its price or value. It answers a simple question: if I bought this property in cash, what percentage would it earn each year?

Because it ignores how you pay for the property, it lets you compare a shop in one city with an office floor in another on the same footing. It is used mostly for income-producing commercial property, though it can be applied to any rented building.

The word capitalisation comes from the idea of converting a stream of income into a single capital value. If a property reliably produces ₹6.8 lakh a year and buyers in the area expect about 7% on their money, then the property is worth about ₹97 lakh. The cap rate is the bridge between income and price.

It is not the same as rental yield. Rental yield usually starts from the rent; cap rate starts from net operating income, after the costs of running the property. The rental yield guide covers the difference.

Cap rate formula and how to find NOI

NOI is the figure people most often get wrong, so build it in order.

1. 1Start with the rent the property would earn if it were fully let for the year.
2. 2Subtract an allowance for vacancy and unpaid rent.
3. 3Subtract operating expenses: property tax, repairs and maintenance, insurance, management fees and utilities you pay.
4. 4The remainder is NOI. Divide it by the price.

Leave out loan interest and principal, depreciation, income tax, and big one-off capital items such as a new roof. They matter for your own return but not for the property's cap rate.

Worked example: a ₹1.1 crore shop

The vacancy allowance and the management fee are assumptions you should make even if you collect the rent yourself. They stop a property that is currently doing well from looking better than a normal year.

Using cap rate to estimate value

The formula works in reverse. If similar properties in the area trade at a particular cap rate, divide NOI by it to estimate what this one is worth. This is the standard way commercial buyers and valuers price an income property.

Where does the market cap rate come from? Usually from recent sales of comparable properties: divide each sold property's NOI by its sale price and look at the range. Using one or two sales is a weak basis, so gather as many comparables as you can and note how similar their tenants and leases are.

Notice the direction. When the cap rate falls from 8% to 6%, the same NOI is worth about ₹28 lakh more. That is why property prices rise when investors accept lower returns, even if rents have not changed at all.

A one percentage point change in the cap rate moves the value by more than ₹12 lakh here, so small errors in either the NOI or the cap rate are expensive. Treat the output as a range.

Comparing properties and reading the number

Read the table row by row. The office floor has the smallest price and the highest cap rate at 6.50%, the shop sits in the middle, and the warehouse has the lowest at 6.00%. The differences look small, but on a ₹1.25 crore purchase half a percentage point is ₹62,500 of income every year.

The warehouse has the largest NOI but the lowest cap rate: you are paying more per rupee of income. That may be right if the tenant is stronger or the lease is longer.

A higher cap rate usually reflects higher risk or weaker growth, not a bargain. A lower one often reflects stable tenants or a better location. Always ask why a number is high before treating it as an opportunity.

Cap rate is also blind to financing. With a yearly loan payment of ₹4,80,000 on the shop, the cash left after debt would be 6,82,880 − 4,80,000 = ₹2,02,880, which is a very different story from a 6.21% cap rate.

Cap rate versus the cost of borrowing

A cap rate is also a quick test of whether borrowing makes sense. Assume a loan rate of 9% for this example. If the property earns a 6.21% cap rate, every rupee you borrow costs more than it earns from the property in income terms.

That does not make the purchase wrong. Rents may rise and the price may grow, so total return can still be good. But you are then relying on growth rather than income, and your monthly cash flow will be thin or negative until the rent catches up.

When the cap rate is above your borrowing rate, leverage works for you from the first year. When it is below, you are making a bet on the future. Knowing which situation you are in is the real value of the number.

Mistakes people make with cap rates

• Putting loan EMI into the expenses. NOI is calculated before financing.
• Using the rent the seller promises, not the rent the property has actually collected.
• Forgetting vacancy, or assuming 100% occupancy every month.
• Comparing cap rates of properties with different lease lengths or tenant quality as if they were the same risk.
• Treating cap rate as total return. It ignores price growth, tax and the cost of the money you borrowed.

Capital expenditure deserves its own line even though it sits outside NOI. A building needs a new lift, a repainted exterior or a roof repair every so often. Set aside a yearly reserve so that your comparison does not reward the owner who has deferred maintenance.

Check the leases before relying on any single figure, and keep a copy of how you built the NOI so you can show a lender or partner. For a quick check of total return including growth, use the ROI calculator.