The cap rate formula, fully unpacked
Cap rate has one formula: Cap Rate = Net Operating Income (NOI) ÷ Property Price. The result is expressed as a percentage. A property with $42,000 NOI purchased for $500,000 has an 8.4% cap rate.
The formula is simple. What trips people up is calculating NOI correctly. NOI is not gross rental income. It's what's left after you strip out every operating expense except mortgage payments.
NOI = Gross Rental Income − Vacancy Allowance − Property Management − Insurance − Property Taxes − Maintenance
- Gross rental income: Total rent collected at full occupancy. For STRs, use projected annual revenue from comparable Airbnb listings — not asking price estimates.
- Vacancy allowance: Typically 5–10% for long-term rentals, 15–25% for STRs depending on seasonality.
- Property management: 8–12% of gross revenue for long-term; 20–30% for full-service STR management (cleaning, guest comms, restocking).
- Insurance: Standard landlord policy plus STR rider if applicable. Get an actual quote — don't estimate.
- Property taxes: Annual amount from the county assessor, not a percentage guess.
- Maintenance: Budget 1–1.5% of property value annually. STRs experience higher wear — budget toward the higher end.
Why mortgage is excluded from cap rate
This is the most common point of confusion. The reason mortgage payments are excluded is deliberate: cap rate is a property metric, not an investor metric.
Consider two investors buying the same $500,000 property. Investor A puts 40% down, Investor B puts 10% down. They have very different monthly mortgage payments and very different cash flow. But the property's income-generating ability is identical. Cap rate measures that property-level quality, independent of who's buying it or how they're financing it.
This is what makes cap rate useful for comparison shopping. You can compare a property in Austin to one in Nashville to one in Scottsdale on an apples-to-apples basis. The financing terms each investor uses are irrelevant to that comparison.
Cap rate benchmarks by market type
Cap rates vary significantly by market, property type, and asset class. Here's the practical reference range:
| Market Type | Typical Cap Rate Range | Key Driver |
|---|---|---|
| Urban core long-term rentals (NYC, SF, LA) | 3–5% | High property prices compress yield; return comes from appreciation |
| Suburban long-term rentals | 5–7% | Moderate prices, stable occupancy, lower management overhead |
| Mid-tier STR markets | 7–10% | Higher revenue potential vs. long-term; seasonal occupancy dips |
| High-demand STR markets (Smoky Mtns, Joshua Tree, Gulf Coast) | 10–15% | Peak demand far exceeds supply; high nightly rates offset seasonality |
When cap rate is the wrong metric
Cap rate is powerful for comparison, but it has two scenarios where it misleads:
1. STRs with extreme seasonality. A beach house that earns $8,000 in July and $400 in January has an average monthly revenue that doesn't tell you much. A cap rate built on average annual revenue smooths over the cash flow problem of actually surviving the off-season. Use monthly cash flow projections alongside cap rate for highly seasonal properties.
2. Rapidly appreciating markets. A 4% cap rate in a market where property values have been growing 10–12% per year isn't the same as a 4% cap rate in a flat market. Appreciation offsets low yield — but appreciation is not guaranteed, while your mortgage payment is. Know which return component you're actually underwriting.
Cap rate vs. cash-on-cash return: which to use when
Use cap rate to compare properties. When you're evaluating five listings across three markets, cap rate lets you rank them by income quality without your financing muddying the comparison.
Use cash-on-cash return to evaluate your actual investment. Cash-on-cash = annual pre-tax cash flow ÷ total cash invested. This accounts for your mortgage payments, your down payment, your closing costs. It answers: "Given how I'm financing this, what percentage return am I getting on the cash I actually put in?"
A property with a strong cap rate can have weak cash-on-cash if you're financing at a high interest rate. A property with a low cap rate can still produce strong cash-on-cash if you bought it at a discount or secured favorable financing. Run both numbers.
Worked example: $500,000 STR property
Let's run through a real calculation. A property is listed at $500,000 in a mid-tier STR market. Comparable Airbnb listings in the same zip code, same bedroom count, show projected annual gross revenue of $60,000.
Operating expenses:
- Vacancy allowance (20% for STR seasonality): $12,000
- STR management fee (25% of gross): $15,000 → applied against gross, so subtract from revenue
- Insurance (landlord + STR rider): $2,400/year
- Property taxes: $6,500/year
- Maintenance (1.5% of value): $7,500/year
- Gross revenue: $60,000
- Less vacancy (20%): −$12,000 → Effective Gross Income: $48,000
- Less management (25% of gross): −$15,000
- Less insurance: −$2,400
- Less property taxes: −$6,500
- Less maintenance: −$7,500
- NOI: $14,600
- Cap Rate: $14,600 ÷ $500,000 = 2.9%
2.9% is below the mid-tier STR benchmark of 7–10%. This property is overpriced relative to its income potential, or the gross revenue estimate needs to be higher. At $60,000 gross you'd need a purchase price around $200,000 to hit a 7% cap rate — which tells you either the listing price needs to come down significantly, or this is not an investment purchase.
This kind of analysis, run across 20 listings in an afternoon, is exactly where STRInvest accelerates the workflow. It pulls projected STR revenue from actual comparable Airbnb listings in the same market and calculates cap rate and cash-on-cash return for any Zillow or Redfin listing — without you opening a spreadsheet.