DSCRWorked example
The cap rate on this duplex is 5.4%. Here is the math behind it. The unit rents for $2,400/month, or $28,800/year. Operating expenses (taxes, insurance, management, maintenance, vacancy) run 40% of rent, or $11,520. That leaves NOI of $28,800 − $11,520 = $17,280. At a $320,000 purchase price, the cap rate = $17,280 ÷ $320,000 = 5.4%.
Across the 18 metros we track, modeled cap rates currently sit roughly between 3.5% and
5.7% on seed pricing, so a 5.4% figure lands near the top of today's range. See where each
market falls on the Investor Yield Index.
What to include and exclude
The line that trips up most investors is financing. NOI is calculated before the mortgage, so a property has the same cap rate whether you pay cash or borrow 80%.
| Include in NOI | Exclude from NOI |
|---|---|
| Property taxes | Mortgage principal & interest |
| Insurance | Depreciation |
| Property management | Capital expenditures / major rehab |
| Maintenance & repairs | Your personal income tax |
| Vacancy allowance | One-time transaction costs |
Common mistakes
- Using gross rent instead of NOI. That gives gross yield, which runs higher and is not the same thing.
- Subtracting the mortgage. Once you include financing, you are computing cash-on-cash return, not cap rate.
- Ignoring vacancy. Reserve for it even on a leased unit, since tenants turn over.
- Folding in capital improvements. A new roof or rehab is a capital cost, not an operating expense.
For benchmarks by market and risk level, see what is a good cap rate.