The capitalization rate is the fastest way to compare income properties: it tells you what yield a property produces on its price, ignoring financing. If you only learn one metric, learn this one — and learn where it lies to you.
What it measures
Cap rate = net operating income (NOI) divided by property value. A property with $18,000 of NOI valued at $300,000 has a 6.0% cap rate. Because debt is excluded, two investors with completely different loans can compare the same building on equal footing. It is a measure of the PROPERTY, not of your deal.
Typical ranges
Stabilized residential rentals in the US mostly trade between 4–8%. Lower cap rates (3–5%) usually mean lower perceived risk: strong markets, newer buildings, reliable tenants. Higher cap rates (8–12%) price in risk — soft markets, deferred maintenance, or rougher tenant profiles. A "high" cap rate is not automatically a bargain; it is the market telling you something needs work.
Worked example
A duplex rents for $2,600/month total, so $31,200/year. Operating expenses — taxes, insurance, maintenance, management, vacancy allowance — run $11,200/year. NOI is $20,000. At a $320,000 purchase price, the cap rate is $20,000 ÷ $320,000 = 6.3%. If comparable duplexes in the area trade at a 5.5% cap, this one is priced attractively — or the expense estimate is optimistic. Check which.
When this rule of thumb breaks
Cap rate assumes stabilized, honest numbers. It misleads when: NOI uses asking rents instead of actual rents; expenses omit management or reserves (common in listings); the property needs major capex the price doesn't reflect; or you are buying for appreciation or redevelopment, where current income is beside the point. And on small portfolios a single vacancy month swings NOI enough to move the cap rate a full point — compute it on a trailing 12 months, not one good month.