What Is Cap Rate: Capitalisation Rate Meaning, Formula & Use In Real Estate

The Capitalisation Rate (Cap Rate) shows the annual return you earn from a property compared to its current market price. 

For example, Karan wants to invest in a small commercial shop. So, he finds two properties:

• Property A costs ₹50,00,000 and gives a yearly rental income of ₹5,00,000.
   
• Property B costs ₹70,00,000 and gives ₹5,60,000 annually.

Karan calculates the cap rates for each property to determine where to invest as shown in the table below. 
 

Although Property B gives a better annual rent and low risk, Karan picks Property A for now because it gives him higher returns (10%) based on value. He knows that it's not enough to look at the annual rental income alone. In this blog, let’s learn what cap rate is, how to calculate it, and how you can use it.

What Is Capitalisation Rate?

Cap rate is an abbreviation for capitalisation rate. It tells you the percentage return you would get on a real estate investment if you bought it fully in cash.  In simple terms, it shows how profitable a property is before loans, taxes or depreciation.  

If you buy a building for ₹1,00,00,000 and it generates ₹7,00,000 a year in net income, the cap rate is 7%.

So, what does the cap rate measure?

It’s the ratio of the Net Operating Income (NOI) to the property’s market value. This means it compares how much the property earns (after expenses) to how much it’s worth.

Here’s the basic idea:

• A higher cap rate (like 10%) usually means higher returns, but the property might be in a riskier area or need more maintenance.
   
• A lower cap rate (like 4% or 5%) often means a safer investment, like a prime-location commercial property, but with less return.

Cap rates are mostly used for rental properties like apartments, office buildings, or shops where regular rental income is expected.

How Do You Calculate Capitalisation Rate?

The formula to calculate the cap rate is very straightforward. It is:

Cap Rate = (Net Operating Income ÷ Property Value) × 100

Let’s break this down:

1. Net Operating Income (NOI): It is the yearly income the property earns after subtracting regular costs, like:
    

• Property tax
• Repairs and maintenance
• Insurance
• Property management fees
  
  This does not include loan payments, interest, or income tax.
   

2. Property Value: It is what the property would sell for today in the market.

For example, you buy a property worth ₹1,00,00,000. It earns ₹10,00,000 per year after all expenses. That is your NOI.

Read More – How to Calculate Return on Investment (ROI) – Step-by-Step Guide

So, 

Cap Rate = ₹10,00,000 ÷ ₹1,00,00,000 × 100 = 10%

This means you can expect to earn 10% of the property’s value back each year. In this situation, we have assumed that you have not taken out any loans.

Alternate version:

Sometimes people use the purchase price instead of the market value. That’s okay, but it might give misleading results if the market has changed since you bought it.

If you bought that same property 10 years ago for ₹50,00,000, using the old price gives:

Cap Rate = ₹10,00,000 ÷ ₹50,00,000 × 100 = 20%

But since the property is now worth more, this doesn’t reflect the current market return. That’s why investors usually use current market value to get an accurate picture.

We have summarised both versions in the table given below:
 

The standard version is used when you compare properties in today’s market price. The alternative version is used when you measure returns on what you paid.

What’s Included in NOI (Net Operating Income) and What Is Not?

When you want to know how much a property actually earns you every year, you calculate its Net Operating Income, or NOI. This is what’s left after subtracting the property’s current costs, but before you pay any loans or taxes.

Let’s understand it step by step.

Step 1: You begin by adding up all the money the property brings in. This includes the following:
 

• Rental Income: The total yearly rent from tenants
   
• Other Income: Things like parking fees, laundry machines, storage lockers, vending machines

For example, if you collect ₹12,00,000 in rent and ₹1,00,000 from parking and laundry,
  Total Income = ₹13,00,000

Step 2: Here, you have to subtract the vacancy losses. You won’t always have every unit rented out all year. Some months, a flat might be empty. That’s called a vacancy loss.

For example, if you lose ₹1,50,000 a year due to empty units or unpaid rent,
Net Income = ₹13,00,000 – ₹1,50,000

        = ₹11,50,000

Step 3: Now subtract the day-to-day costs of running the building. These include:
 

• Property taxes
   
• Insurance
   
• Repairs and maintenance
   
• Utility bills (electricity, water, waste)
   
• Property management fees
   
• Cleaning, admin, or advertising costs
   

For example, if your operating expenses total ₹4,00,000 per year,
NOI = ₹11,50,000 – ₹4,00,000 

       = ₹7,50,000

What Is NOT Included in NOI

Some people mistakenly include debt payments or taxes in NOI, but that’s incorrect. Here’s what you should leave out:
 

So, if your loan EMI is ₹3,00,000 a year, it does not affect the ₹7,50,000 NOI.

How Is Cap Rate Used in Indian Real Estate?

By now, you know what the Cap Rate is, how it’s calculated, and everything else in between. But what you still might not know is where to actually use it. This kind of practical knowledge is often missing from the Indian education system, but not from our blogs. Here are a few areas where you can apply the Cap Rate:

1. Compare Properties Easily

Use the cap rate to compare investment potential across cities or property types. In Indian metros, typical residential rental yields are:

• Bengaluru: 3.2% to 4.5%
• Mumbai: 2.5% to 4% 
• Gurugram: 4%

With the rental yields, you can get an idea of the NOI for the respective cities. Then, divide the value by the property price to calculate the exact cap rate. Higher cap rate means higher rental income, but you have to compromise on the locality of that property..

Also Read - Real Estate Price Trends in 2025: Is It a Good Time to Invest?

2. Estimate Market Value Using NOI

If you reverse the cap rate formula, you can get the approximate fair property value:

Property Value = NOI ÷ Cap Rate

For example, if a Grade A office generates ₹75,00,000 NOI and the regional cap rate is 7.5%. The estimated property value will be:
Estimated value = ₹75,00,000 ÷ 0.075 

   = ₹10,00,00,000

3. Assess Risk & Market Trends

Cap rate gives an idea of both yield and the risks associated with the property. Homes usually give cap rates of 2–3% a year due to lower rental yields. But commercial properties can earn 7-10%, depending on where they are and what type they are.

Conclusion

Cap rate is the most useful tool in real estate investment. It tells you if a property is worth the money, how fast it’ll earn back your investment, and helps you compare deals without brochures. So, think like your baniya friend. Be analytical, practical, and profit-focused. Let the cap rate guide your next property decision.

Frequently Asked Questions

1. What is the difference between entry and exit cap rates?
Entry cap rate is for purchase value; exit cap rate estimates future resale value based on projected income.

2. How is the cap rate different from IRR?
Cap rate shows yearly income returns; IRR includes total returns over time, including resale value and reinvestment impact.

3. Can I use the cap rate for serviced apartments or co-living spaces?
You can, but income varies monthly, so the cap rate might not reflect the true earning potential of such properties.

4. What if I can’t find the cap rate data in my Indian city?
Use average rental returns or consult local brokers to estimate cap rates in smaller or less-documented Indian cities.

5. Does the cap rate affect how quickly a property sells?
Yes. Higher cap rates attract investors looking for returns, especially in rental-focused commercial real estate segments.

 

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