NOI and cap rate, explained
Net operating income and cap rate are the two figures this site uses to describe a rental property on its own, before any loan is attached to it. Both come out of a short chain of arithmetic — rent, a vacancy haircut, operating expenses, a multiplication by twelve, a division by the property's value — and every link in that chain is a number you enter. This guide walks the chain in order, computes each step with the same engine that runs the Cap Rate Calculator and the Rental Property Calculator, and ends with a plain list of what the ratio does not contain.
The chain, in order
Four steps. Effective rent is the monthly rent multiplied by one minus the vacancy percentage. Monthly operating expenses are subtracted from it. The difference, multiplied by twelve, is net operating income. NOI divided by the property value is the cap rate. The Cap Rate Calculator takes exactly those four inputs and stops at the fourth step; the Rental Property Calculator runs the same four steps on the same inputs and then goes on to subtract the mortgage, which produces cash flow and cash-on-cash return — the subject of the companion guide on cash flow and cash-on-cash return. Nothing in the four steps refers to the loan, and that is the point of the design.
Step one: effective rent
Vacancy is modeled as a steady haircut rather than as discrete empty months. A vacancy allowance of 5% takes 5% off every month's rent; it does not zero out one month in 20. On the reference property used throughout this site — $2,200 of monthly rent with a 5% allowance — the effective rent is $2,090.00. The percentage is the only place the model accounts for time without a tenant, so it also has to carry anything else that interrupts rent: turnover, repairs between tenancies, a slow re-let. The engine accepts any allowance from zero to one hundred percent; above that it refuses the input with the message "Enter a vacancy rate of 100% or less."
Because the allowance scales the rent linearly, each point of vacancy removes the same slice of income. Holding the rent, expenses, and $220,000 value fixed and entering 0%, 5%, and 10% vacancy gives effective rents of $2,200.00, $2,090.00, and $1,980.00; annual NOI of $18,600, $17,280, and $15,960; and cap rates of 8.45%, 7.85%, and 7.25%. The two steps are equal — 0.6 percentage points each — because nothing in the chain bends: the vacancy term multiplies the rent, the expenses are a fixed subtraction, and the value is a fixed divisor. An allowance of zero models a property that is never empty; every figure that follows is computed on that assumption.
Step two: operating expenses, and why the mortgage is not one
The calculators take operating expenses as a single monthly figure. The field label on the Rental Property Calculator describes it as tax, insurance, maintenance, and management — not the mortgage — and the model does not itemize beyond that: whatever total you enter is subtracted from the effective rent each month. Principal and interest are excluded by industry convention. The reason is structural. A loan belongs to a particular buyer and depends on that buyer's down payment, rate, and term; the building's rent and running costs do not change with any of them. Keeping the mortgage out of the expense figure means two people looking at the same property with different loans compute the same NOI and the same cap rate.
The misreading to guard against is putting the mortgage payment into the expense field. On the reference property financed with 20% down at 7% over 30 years, the payment is $1,170.93 a month. Add it to the $650 of operating expenses and the engine still computes — it has no way to know what the figure contains — but NOI drops from $17,280 to $3,229 and the cap rate from 7.85% to 1.47%. That lower number is not a cap rate. It is a levered figure that belongs in the cash-flow calculation, where the mortgage is subtracted on purpose and then divided by the cash invested rather than by the price.
Every dollar of monthly expense becomes twelve dollars of annual NOI, so the expense figure moves the output as much as any single input. With rent, vacancy, and value held at the reference inputs, monthly expenses of $450, $650, and $850 produce NOI of $19,680, $17,280, and $14,880 — each step of $200 a month moves annual NOI by $2,400 — and cap rates of 8.95%, 7.85%, and 6.76%. The model supplies none of these costs itself; an expense figure that omits a recurring cost makes the cap rate describe a property that does not exist.
Step three: net operating income
NOI is the effective rent less operating expenses, multiplied by twelve. The inputs are monthly; the output is annual because the cap rate is an annual yield. On the reference property the monthly margin is $2,090.00 less $650, and twelve of those margins make $17,280 of NOI. Two things it is not: it is not cash flow, because no mortgage has been subtracted, and it is not profit, because no income tax or depreciation appears anywhere in the chain.
The engine does not stop NOI from going negative. Enter $2,300 of monthly expenses against the same $2,090.00 of effective rent and NOI is -$2,520, with a cap rate of -1.15%. The figure is reported rather than hidden: on those inputs the property does not cover its own running costs before any loan is considered, and no financing structure changes that part of the arithmetic.
Step four: cap rate is NOI divided by value
The final step divides annual NOI by the value you enter and expresses the result as a percentage. The denominator is whatever number is in the field: the Cap Rate Calculator labels it property value and the Rental Property Calculator uses the purchase price, and the engine does not know whether that figure is an asking price, an appraisal, or an offer you are testing. This matters because the same NOI divided by different values gives different cap rates. The reference property's $17,280 of NOI is a 7.85% cap rate at $220,000, a 9.82% cap rate at $176,000, and a 6.28% cap rate at $275,000. The building produced identical income in all three cases; only the price under it moved, so the ratio is only as meaningful as the value entered.
The chain works the same way on any inputs. A second property with $1,450 of rent, an 8% vacancy allowance, $520 of monthly expenses, and a $160,000 value has an effective rent of $1,334.00, NOI of $9,768, and a cap rate of 6.11%. A third with $4,800 of rent, 6% vacancy, $1,900 of expenses, and a $610,000 value has an effective rent of $4,512.00, NOI of $31,344, and a cap rate of 5.14%. The third produces more NOI and a lower cap rate than the second, because the ratio measures income relative to value, not income by itself.
Why cap rate ignores financing, and cash-on-cash does not
One way to see the convention at work is to finance the same property three ways. The Rental Property Calculator, given the reference property with $5,000 of closing costs and $3,000 of initial rehab, reports a cap rate of 7.85% with 20% down at 7% over 30 years, 7.85% with 40% down on the same terms, and 7.85% with the full $220,000 paid in cash and no loan at all. The three are identical, and the build of this page checks that they are. The cash-on-cash return for the same three cases is 6.21%, 7.02%, and 7.58%, because that ratio subtracts the mortgage payment ($1,170.93, $878.20, and $0.00 a month respectively) and divides by the cash invested ($52,000, $96,000, and $228,000) rather than by the price. Cap rate answers what the property yields; cash-on-cash answers what a particular buyer's cash earns in it. Comparing one property's cap rate to another's cash-on-cash return compares two different questions.
What the cap rate leaves out
The ratio is a single-year snapshot of operating income against value, and the methodology page lists what the models on this site do not include: income taxes, depreciation deductions, appreciation on rentals, principal paydown as a return component, PMI, financing points, rent growth on investment properties, and market cycles. None of these appears anywhere in the four steps, so the cap rate neither credits nor penalizes a property for them. The model also makes three simplifications of its own: vacancy is a steady percentage rather than a pattern of empty months, operating expenses are one monthly total rather than a line-by-line budget, and the value is a single figure you supply rather than anything the engine estimates.
This sets how to read the output. A cap rate lets you compare properties on their own economics, and it lets you see how an offer price or an expense assumption moves the ratio, as the examples above show. It does not say whether a given figure is adequate: that comparison depends on comparable properties and on the factors the model does not see, and this site does not supply a target. Treat the number as a screen that organizes the inputs, not as a verdict on the deal.
What the engine refuses
The calculators return a message instead of a number when an input cannot produce a meaningful result. A property value of zero is refused with "The property value must be greater than 0." A monthly rent of zero is refused with "The monthly rent must be greater than 0." A vacancy allowance above one hundred percent is refused with "Enter a vacancy rate of 100% or less." Negative figures in any field are refused as well. Operating expenses of zero are accepted, though a cap rate computed on zero expenses describes a property with no running costs.
The examples on this page, in one table
Every row is computed at build time by the engine that runs the calculators.
| Case | Rent | Vacancy | Expenses | Value | Effective rent | NOI | Cap rate |
|---|---|---|---|---|---|---|---|
| Base case | $2,200 | 5% | $650.00 | $220,000 | $2,090.00 | $17,280 | 7.85% |
| Vacancy 0% | $2,200 | 0% | $650.00 | $220,000 | $2,200.00 | $18,600 | 8.45% |
| Vacancy 10% | $2,200 | 10% | $650.00 | $220,000 | $1,980.00 | $15,960 | 7.25% |
| Expenses $450 | $2,200 | 5% | $450.00 | $220,000 | $2,090.00 | $19,680 | 8.95% |
| Expenses $850 | $2,200 | 5% | $850.00 | $220,000 | $2,090.00 | $14,880 | 6.76% |
| Mortgage inside expenses | $2,200 | 5% | $1,820.93 | $220,000 | $2,090.00 | $3,229 | 1.47% |
| Expenses $2,300 | $2,200 | 5% | $2,300.00 | $220,000 | $2,090.00 | -$2,520 | -1.15% |
| Value $176,000 | $2,200 | 5% | $650.00 | $176,000 | $2,090.00 | $17,280 | 9.82% |
| Value $275,000 | $2,200 | 5% | $650.00 | $275,000 | $2,090.00 | $17,280 | 6.28% |
| Second property | $1,450 | 8% | $520.00 | $160,000 | $1,334.00 | $9,768 | 6.11% |
| Third property | $4,800 | 6% | $1,900.00 | $610,000 | $4,512.00 | $31,344 | 5.14% |
Frequently asked questions
What is net operating income (NOI)?
The effective rent (monthly rent less the vacancy allowance) minus monthly operating expenses, multiplied by twelve. It is an annual figure describing what the property itself produces before any mortgage payment, and it is the numerator of the cap rate.
Why are mortgage payments left out of operating expenses?
By industry convention, so that NOI and cap rate describe the property independent of financing. A loan belongs to a particular buyer; the building’s rent and running costs do not change with it. Putting principal and interest into the expense field produces a levered number that is not a cap rate — the mortgage is subtracted later, in the cash-flow calculation.
Is cap rate the same thing as cash-on-cash return?
No. Cap rate divides NOI by the property value and ignores the loan. Cash-on-cash divides annual cash flow — which does subtract the mortgage payment — by the cash actually invested. The same property shows one cap rate under every financing structure and a different cash-on-cash return under each.
Can NOI or the cap rate be negative?
Yes. If monthly operating expenses exceed the effective rent, NOI is negative and so is the cap rate. The engine reports the figure rather than hiding it; a negative result means the property does not cover its own running costs on the inputs entered, before any mortgage is considered.
Which value goes in the denominator?
Whatever you enter. The Cap Rate Calculator asks for a property value and the Rental Property Calculator uses the purchase price; the engine does not distinguish an asking price from an appraisal or from an offer you are testing. The same NOI divided by a higher value gives a lower cap rate, so the ratio is only as meaningful as the value placed under it.
Does the cap rate include appreciation, taxes, or rent growth?
No. The models on this site do not include income taxes, depreciation deductions, appreciation on rentals, principal paydown as a return component, PMI, financing points, rent growth on investment properties, or market cycles. Cap rate is a single-year snapshot of operating income against value — a way to compare properties on their own economics, not a forecast of total return.
Not financial advice: this guide is a general educational explanation of how NOI and cap rate are computed on this site. Market cap rates vary by location, asset class, and conditions — verify with local comparables and qualified professionals. Values entered in the calculators are processed locally in your browser and never transmitted. See the methodology page.