# What Is Cap Rate?

> Cap rate measures a property's income return independent of financing. Learn how to calculate it and what makes a good cap rate for STR investing.

Canonical: https://www.underwriteapp.com/learn/what-is-cap-rate


## Definition

**Capitalization rate** (cap rate) is the ratio of a property's net operating income (NOI) to its current market value or purchase price.

$$\text{Cap Rate} = \frac{\text{Net Operating Income}}{\text{Property Value}}$$

It is expressed as a percentage and answers the question: **if I paid all cash, what income return would I earn?**

## How to Calculate Cap Rate

### Step 1 — Estimate gross revenue

For an STR, gross revenue = projected occupancy × average daily rate (ADR) × 365.

**Example:** 65% occupancy × $200 ADR × 365 days = **$47,450 gross revenue**

### Step 2 — Calculate net operating income

NOI = Gross Revenue − Operating Expenses

Operating expenses for an STR typically include:

| Expense | Typical Range |
|---------|--------------|
| Platform commissions | 3–15% of gross |
| Cleaning | 8–12% of gross |
| Supplies & maintenance | 3–5% of gross |
| Property management | 20–35% of gross (if outsourced) |
| Property taxes | Market-dependent |
| Insurance | $2,000–$6,000/year |
| Utilities | $2,400–$6,000/year |

**Example:** $47,450 gross − $22,000 expenses = **$25,450 NOI**

### Step 3 — Divide by purchase price

**Example:** $25,450 ÷ $350,000 = **7.3% cap rate**

## Cap Rate vs. Cash-on-Cash Return

Cap rate is financing-agnostic. [cash-on-cash-return](/learn/cash-on-cash-return) accounts for your mortgage.

| Scenario | Metric | Value |
|----------|--------|-------|
| All-cash purchase | Cap rate = CoC | 7.3% |
| 25% down at 7% rate | Cap rate | 7.3% |
| 25% down at 7% rate | Cash-on-cash | 4.1% |

## What Moves Cap Rates

- **Location risk** — primary markets with diversified demand command lower cap rates (higher prices relative to income)
- **Asset condition** — newer, turnkey properties trade at lower cap rates
- **STR regulatory risk** — markets with uncertain STR regulations see cap rate risk premiums
- **Interest rates** — as financing costs rise, buyers require higher cap rates to maintain positive leverage

## Common Mistakes

**Using gross revenue instead of NOI.** Gross yield and cap rate are different. Always use NOI (after all operating expenses, before debt service).

**Forgetting to include capex reserves.** Budget 5–10% of gross revenue annually for repairs, replacements, and upgrades. This is an operating cost.

**Benchmarking against residential cap rates.** STR operating expenses are higher than long-term rental expenses. A long-term rental at 5% cap rate is not equivalent to an STR at 5% cap rate.