The question everyone asks and nobody answers straight
Ask ten investors what a good cap rate is and you will get a confident number from each of them, and the numbers will disagree by three full points. That is not because nine of them are wrong. It is because cap rate is a comparison tool, not a grade, and a comparison only means something against the right peer group. A 5% cap can be a great buy in one zip code and a 9% cap can be a disaster two states away.
So instead of handing you a magic number, I want to do two things in this post. First, compute a cap rate properly on a realistic fourplex, line by line, because most of the damage happens in the expense lines people skip. Second, show you what the number actually tells you, including the part almost nobody mentions: cap rate is also a measure of how violently the price can move when the market changes its mind.
Cap rate in one formula
Cap rate is net operating income divided by purchase price. NOI is all the income the property realistically produces in a year, minus all operating expenses: taxes, insurance, management, repairs, reserves, utilities you pay, vacancy. What it deliberately excludes is your mortgage. Cap rate describes the property, not your financing, which is exactly why two buyers with wildly different loans can compare the same building on equal footing.
That exclusion is also the number one source of confusion. If you want to know what your actual cash earns after the loan payment, that is a different metric with a different job, and I walk through the difference in cap rate vs cash on cash. For now, hold onto this: cap rate answers 'what does this building yield, unlevered,' nothing more.
The fourplex, line by line
Here is a deal shaped like hundreds you will see in midwestern and southern US markets. A fourplex listed at $480,000, each unit renting for $1,250 a month. Gross scheduled rent is 4 times $1,250 times 12, which is $60,000 a year. Knock off 5% for vacancy, $3,000, and effective gross income lands at $57,000.
Now the part sellers hate: expenses. Property taxes $5,800. Insurance $2,600. Management at 8% of collected rent, $4,560. Repairs and maintenance $3,200. A capital expenditure reserve of $2,400 for the roof and water heaters that are aging whether you budget for them or not. Water, sewer, and trash that the owner pays on this building, $2,640. Lawn and snow, $800. Total operating expenses: $22,000.
NOI is $57,000 minus $22,000, which is $35,000. Divide by the $480,000 price and the cap rate is 7.29%. You can rerun this with your own numbers in the cap rate calculator in about a minute, and I would also glance at the gross figure while you are at it: $60,000 of rent on a $480,000 price is a 12.5% gross yield, which the rental yield calculator will confirm. Gross yield is a fast screen; cap rate is the real conversation.
So is 7.29% good?
It depends on three things, and I mean that literally, not as a dodge. First, the market. Caps compress in expensive coastal metros where buyers accept lower yields in exchange for appreciation and liquidity, and they widen in smaller markets where growth is slower and buyers demand more current income. The same building tends to trade at a very different cap in Cleveland than in San Diego, and neither market is wrong.
Second, asset class and condition. A stabilized building with long tenants and a new roof deserves a lower cap than a tired one with month-to-month tenants, because the income is more certain. When a listing shows a fat cap rate, my first question is no longer 'what a deal' but 'what does the seller know about this income that I do not.'
Third, interest rates. Investors always compare a property's yield to what risk-free money pays. When treasury yields and mortgage rates rise, buyers demand higher caps to compensate, and prices fall to deliver them. A 6% cap felt generous when safe money paid almost nothing. It feels a lot thinner when it does not. So 'good' is a moving target that follows rates, which is why memorizing a threshold from an old forum post is a mistake.
Cap rate is also a price risk dial
Here is the lens that changed how I read these numbers. Flip the formula around: price equals NOI divided by cap rate. Our fourplex earns $35,000. At a 6% cap the market values that income at $583,333. At 7%, $500,000. At 8%, $437,500. The income never changed, and the value swung by almost $146,000 between the extremes.
Look at the step from 7% to 8%: value drops from $500,000 to $437,500, which is 12.5% of your price evaporating from a one point move in market sentiment. And the lower the cap you buy at, the more brutal this math gets, because each point is a larger fraction of a small yield. That is the hidden risk in low-cap trophy markets: you are not just accepting less income, you are holding an asset whose price is more sensitive to rate moves. High cap rates carry risk in the income; low cap rates carry risk in the price.
Where cap rate lies to you
The formula is honest; the inputs usually are not. Listing pro formas routinely show market rents nobody is paying yet, vacancy at 3% in a 7% town, no management because 'you will self-manage,' and no capex reserve at all. Early on I underwrote a triplex using the broker's expense sheet because it looked official, and the real cap rate turned out to be almost two points below the marketing number once actual taxes and a management fee entered the picture. That mistake cost me nothing but the offer I almost made, and it taught me to rebuild every NOI from scratch.
The other quiet lie is time. Cap rate is a snapshot of one year. It says nothing about the rent growth, the tax reassessment after your purchase, or the $18,000 sewer line waiting under the parking pad. Treat it as the opening line of the analysis, not the verdict.
And remember what it structurally cannot see: your loan. A property can have a beautiful cap rate and still produce negative cash flow after debt service at today's rates. Before any offer, I run the levered picture in the cash on cash return calculator, because that is the number my bank account experiences.
How I actually use it
Three jobs. As a screen: compute my own cap from my own expense assumptions and discard anything absurd before wasting a weekend. As a comparison: rank similar buildings in the same submarket, where the differences are meaningful. And as a price check at exit: if I assume I will sell at a lower cap than I bought at, I am betting on market sentiment, and I want to make that bet consciously rather than by accident in cell C14.
One note for the record: everything in this post is arithmetic on stated assumptions, not financial advice. Your market, your taxes, and your risk tolerance are inputs I cannot see from here. Run your own numbers, and if you are earlier in this journey than fourplexes, my list of first rental property mistakes covers the errors that cost real money before cap rate even matters.
Questions people ask
There is no universal number. Caps run lower in expensive, high-growth metros and higher in slower markets, and the whole scale shifts with interest rates. The useful move is comparing your computed cap against similar buildings in the same submarket, not against a memorized threshold.
No. Cap rate is net operating income divided by price, and NOI excludes debt service on purpose. That makes it a clean way to compare properties regardless of financing, but it means a fine cap rate can still cash flow negative once your loan payment enters.
Because price and perceived risk move opposite each other. Buyers demand more yield from properties with shakier income, rougher condition, or slower markets. A high cap is compensation for something. The job is finding out what.
Value equals NOI divided by cap rate, so on $35,000 of NOI, moving from a 7% to an 8% cap drops value from $500,000 to $437,500, a 12.5% decline with no change in income. Lower starting caps make the same one point move proportionally more painful.
