Cap rate and NOI, explained simply

If you learn only two pieces of real estate math, make them net operating income and capitalization rate. NOI tells you how much money a property actually produces; cap rate tells you what yield that income represents relative to the price. Together they're the language investors use to compare wildly different properties on the same footing — a duplex in Ohio and an apartment building in Texas — and to sanity-check whether a price makes sense. They're simpler than they sound.

Net operating income: what the property earns

NOI is the income a property generates after operating expenses, but before the mortgage and before income taxes. You start with the effective gross income (all rent and other income, minus a vacancy allowance), then subtract every operating expense: property taxes, insurance, maintenance, property management, utilities you pay, and reserves for big-ticket replacements. What's left is NOI. Crucially, NOI does NOT subtract the mortgage payment — that's deliberate, because it lets you measure the property's earning power independent of how any particular buyer financed it.

Cap rate: the yield the income represents

Cap rate is NOI divided by the property's price (or value): cap rate = NOI ÷ price. If that fourplex costs $300,000 and produces $23,570 of NOI, its cap rate is about 7.9%. You can read a cap rate as 'the unlevered yield' — the annual return the property's income would give a cash buyer, ignoring appreciation and financing. It's the single fastest way to compare income across properties of different prices, and to work backward from a required yield to a maximum price you'd pay.

What a cap rate is actually telling you

• Higher cap rate = higher income yield, but usually higher risk or hassle: older buildings, tougher neighborhoods, slower-growth markets, or more management intensity.
• Lower cap rate = lower income yield, but often lower risk and higher expected appreciation: expensive coastal cities frequently trade at 3-5% caps because buyers pay up for growth and stability.
• Cap rates are set by the market, not by you: comparable sales in an area establish the going cap rate, which is why the same NOI is worth more in a low-cap market than a high-cap one.
• A cap rate is a snapshot at today's income and price — it says nothing about future rent growth, appreciation, or your financing, all of which drive your actual total return.

Using them together

Same income, very different prices — and the cap rate explains why in one number. Property A pays you more today per dollar invested; Property B is a bet that rents and values will climb faster over time. Neither is 'right' — the cap rate just makes the tradeoff visible so you can choose it deliberately instead of by accident.

The bottom line

NOI is what a property earns after operating expenses but before the mortgage; cap rate is that NOI divided by price, expressed as a yield. Use NOI to see a property's true earning power, use cap rate to compare properties and reverse-engineer a fair price, and remember that neither includes your financing — so pair them with cash-on-cash return to evaluate your actual deal. Master these two numbers and you can read any listing's real story in about sixty seconds, which is exactly how experienced investors filter the many bad deals from the few good ones.