Cap rate, short for capitalization rate, is a property's annual net operating income divided by its value or purchase price, written as a percent. It strips out financing and shows what a property earns on its own, so you can line up two buildings of different prices and compare them on the same scale.
Because it ignores your mortgage, two investors looking at the same fourplex will calculate the same cap rate even if one pays cash and the other borrows 75 percent. That is the point: the cap rate describes the asset, not your deal terms.
In practice
Say you are looking at a duplex listed for $340,000. It rents for $1,500 a unit, so $3,000 a month and $36,000 a year in gross rent. You subtract a realistic vacancy allowance and every operating cost: insurance, property tax, repairs, a management reserve, water. Suppose those land at $15,400 for the year. That leaves $20,600 of net operating income.
Cap rate = net operating income ÷ value = $20,600 ÷ $340,000 = 6.06%
Notice what is not in that math: no loan payment, no principal, no interest. Operating costs only. If you ran the same building at a $300,000 price, the cap rate climbs to 6.87%, which is the lever a lower offer pulls. You can run your own numbers with the cap rate calculator before you ever sign anything.
Why it matters to a small landlord
For a 1-to-10 unit owner, the cap rate is a sanity check on price, not a promise of what you take home. A seller's pro forma will quote a high cap rate by lowballing expenses and assuming zero vacancy, so the real work is rebuilding the net operating income from honest costs before you trust the percent. The cap rate also tells you nothing about your monthly cash position once a mortgage is attached; for that you size the deal with cash-on-cash return, which does count your loan and your down payment. A property can show a fine cap rate and still bleed cash every month at today's rates.
Read the cap rate next to its cousins. The net operating income is the numerator that everything hinges on, the gross rent multiplier is the faster but blunter screen that skips expenses entirely, and cash-on-cash return is the one that tells you whether the deal feeds you or starves you. Used together, they keep a single flattering number from talking you into a bad building.