What is Rental Yield / Cap Rate?
Rental yield is the annual return a property generates from rent as a percentage of its purchase price or current value. Gross yield uses rental income only, while net yield (equivalent to cap rate) deducts all operating expenses. It is the primary metric for US investment property analysis and portfolio comparison. Estimate your mortgage costs with the Mortgage Calculator and upfront costs with the Closing Costs Calculator.
The Rental Yield / Cap Rate Formula
Formula
Gross Yield = (Annual Rental Income ÷ Purchase Price) × 100 Cap Rate = ((Annual Rental Income − Operating Expenses) ÷ Purchase Price) × 100
Operating expenses include property taxes, insurance, property management (8-10%), maintenance and CapEx reserves (10-15%), vacancy allowance (5-8%), and HOA if applicable. Cap rate excludes mortgage debt service.
Calculating Rental Yield / Cap Rate: Step-by-Step
Worked example
A $250,000 single-family rental in Indianapolis rents for $1,750/month with annual operating expenses of $7,500 (taxes $3,000, insurance $1,200, maintenance $2,500, vacancy $800).
- 01Annual rental income = $1,750 × 12 = $21,000
- 02Gross yield = ($21,000 ÷ $250,000) × 100 = 8.4%
- 03Net operating income (NOI) = $21,000 − $7,500 = $13,500
- 04Cap rate = ($13,500 ÷ $250,000) × 100 = 5.4%
Result
Gross yield of 8.4% and cap rate of 5.4%. The 3.0% gap between gross and net highlights the importance of accounting for operating expenses, especially property taxes and maintenance reserves, when evaluating investment properties.
Why Rental Yield / Cap Rate Matters
Investment comparison
Cap rate lets you compare property returns directly with stocks, bonds, and REITs. A 6% cap rate with 4-5% appreciation competes well with the S&P 500 once you factor in leverage and tax advantages (depreciation, 1031 exchange).
Portfolio decisions
Comparing cap rates across your portfolio identifies underperformers. A property at a 4% cap rate in Austin or Nashville may be worth holding for appreciation, while a 9% cap rate in Cleveland is a pure cash-flow play. Total return combines both.
Financing feasibility
DSCR (Debt Service Coverage Ratio) lenders require a minimum 1.20-1.25 ratio of NOI to annual debt service. A property with a 5% cap rate purchased with a 7% mortgage rate will not meet DSCR requirements without a large down payment. Calculating yield before applying tells you whether the deal is financeable and how much equity you need to inject.
Common Rental Yield / Cap Rate Mistakes
Using gross yield for decisions
Gross yield of 9% sounds excellent, but if operating expenses eat 40-50% of income, your cap rate is 4.5-5.4%. Always calculate NOI-based cap rate, it is the number that hits your pocket before debt service.
Ignoring vacancy and CapEx
Budget 5-8% vacancy and 10% of rent for CapEx reserves (roof, HVAC, water heater). A 6-week vacancy reduces annual income by 11.5%. Tenant turnover also incurs leasing fees (typically 50-100% of one month's rent through a property manager).
Conflating cap rate with cash-on-cash return
Cap rate measures property-level return before debt service. Cash-on-cash return measures return on your actual invested capital after mortgage payments. A property with a 6% cap rate financed at 75% LTV and 7% interest may produce only a 2-3% cash-on-cash return. When leverage costs exceed the cap rate, the property is cash-flow negative despite a healthy-looking yield.
Rental Yield / Cap Rate Industry Benchmarks
Source: NAR Investment & Vacation Home Buyers Report and RealPage Analytics