Is a higher cap rate always better?
No. A higher cap rate means more net operating income for each dollar of price, but markets price risk into cap rates. Properties with less reliable tenants, higher turnover, deferred maintenance or weaker locations usually trade at higher cap rates. Compare cap rates only between similar properties, and check whether the income behind the number is real and sustainable.
Why higher-cap-rate properties are cheaper for their income
Buyers pay more for income they trust. A newer building on a stable street with long-term tenants attracts many buyers, which pushes its price up and its cap rate down. A property with frequent vacancies, an aging roof or a shrinking local economy attracts fewer buyers, so it sells for less relative to its income - a higher cap rate.
A higher cap rate can still be a good buy if you can reduce the risk the market is charging for - for example by fixing management problems or completing deferred work - but you are being paid to take on that work and risk, not getting a free return.
Worked example: two properties at the same price
Two $400,000 rentals with different cap rates
Illustrative example - round numbers, not current market data. Calculated with Reaixo's calculator engines.
Assumptions
- Property A (stable street, newer systems)
- $2,900 rent, 4% vacancy, $11,000 expenses
- Property B (high turnover, old roof and furnace)
- $3,600 rent, 12% vacancy, $12,500 expenses
- Property B deferred maintenance
- $35,000 due within two years
| Step | Calculation | Result |
|---|---|---|
| 1. Property A NOI | $2,900 × 12 × (1 − 4%) − $11,000 | $22,408 |
| 2. Property A cap rate | $22,408 ÷ $400,000 | 5.60% |
| 3. Property B NOI | $3,600 × 12 × (1 − 12%) − $12,500 | $25,516 |
| 4. Property B cap rate on price | $25,516 ÷ $400,000 | 6.38% |
| 5. Property B cap rate on price plus deferred work | $25,516 ÷ $435,000 | 5.87% |
Cap rate A vs B (B after deferred work): 5.60% vs 6.38% (5.87%). Property B's higher cap rate is the market pricing in more risk: higher vacancy, more turnover and $35,000 of near-term repairs. Counting that work as part of the price narrows the gap, and B's income is less certain to arrive.
What this calculation leaves out
- NOI is a one-year estimate; a higher cap rate built on optimistic rent is not a real return.
- Cap rate ignores financing, appreciation and how quickly the property could be sold.
Cap rate matrix: NOI against value
Cap rate starts from NOI - income after vacancy and operating expenses - never from gross rent. The matrix shows how the rate moves when NOI or the value changes.
- Net operating income
- $24,000
- Effective gross income $34,200
- Cap rate
- 6.00%
- NOI ÷ value
- Gross yield (not the cap rate)
- 9.00%
- Rent ÷ value ignores expenses
| NOI \ Value | $360,000 | $380,000 | $400,000 | $420,000 | $440,000 |
|---|---|---|---|---|---|
| $21,600 | 6.00% | 5.68% | 5.40% | 5.14% | 4.91% |
| $24,000 (yours) | 6.67% | 6.32% | 6.00% ◀ | 5.71% | 5.45% |
| $26,400 | 7.33% | 6.95% | 6.60% | 6.29% | 6.00% |
Formula
NOI = Gross income × (1 − Vacancy %) − Operating expensesCap rate = NOI ÷ Property value × 100Assumptions
- Operating expenses exclude the mortgage, depreciation and capital improvements.
- Cap rate ignores financing; compare it only with properties of a similar type and location.
What to check behind a high cap rate
- Is NOI based on actual collected rent and real expenses, or on a seller's pro forma?
- Is vacancy realistic for the neighbourhood and the unit type?
- What capital work is due in the next five years, and is it in the price?
- Is the tax bill likely to be reassessed after your purchase?
- How easily could you sell or refinance the property later?
Frequently asked questions
What is a good cap rate?
There is no single good number. Cap rates vary by market, property type and risk; compare against recent sales of similar properties in the same area.
Why do cap rates rise when interest rates rise?
Often, because buyers who borrow need more income per dollar of price to keep their returns, so prices fall relative to income. The relationship is not mechanical and varies by market.
Can a low cap rate be a good investment?
Yes. Low-cap-rate properties often have stable income, lower risk and stronger appreciation potential, though they usually produce less cash flow when financed.
Calculators and guides
Recommended next step
Rebuild NOI from real rent and expenses before trusting a listed cap rate.
Check a cap rate with your own numbers →Sources and review
No regulator defines these terms; the page follows common industry practice and labels rules of thumb as such.
Where this applies: Not regulated. Investment ratios and budgeting allowances are industry conventions and rules of thumb, not requirements.
Last reviewed: · Updated:
Worked examples use illustrative round numbers, not current market data. Rates, limits and program rules change - confirm current figures with your lender or a qualified professional.
General educational information, not financial, legal, tax or real estate advice. Rules vary by loan program, transaction and location - verify important decisions with qualified professionals.