Cap rates have helped build some of the best real estate investment portfolios out there.
Take Ryan Dossey, co-founder of Call Porter, for example. By using formulas like the cap rate, he was able to identify and acquire over 150 rental units—building a 7-figure real estate portfolio in just two years.
But what exactly does cap rate mean?
What’s considered a good cap rate?
And how can you use cap rates to build your own real estate investment portfolio?
Below, we’re going to fully explain what “cap rate” means, we’ll provide some examples and then give you three different formulas to calculate it.
Oh, and we’ll also look at how Ryan Dossey built that portfolio using tools like Call Porter.
Let’s get started!
What Does “Cap Rate” Mean?
The capitalization rate (also known as cap rate) is one of the most widely used calculations in the world of real estate investing.
In essence, it estimates an investor’s potential return on investment.
The cap rate also indicates how long it will take to recover the invested amount in a property. For example, a property with a cap rate of 10% will take approximately 10 years to recover the investment.
That said, the cap rate isn’t suitable for every type of real estate.
It’s not ideal for raw land, fix-and-flip properties, or short-term rentals. Instead, it’s most commonly used for property investments that generate steady rental income, such as:
- Multifamily rental properties
- Apartment buildings
- Single-family rental homes
- Rentable townhomes
- Commercial real estate
If you’re focused on building a long-term, buy-and-hold portfolio, cap rate is one of the most essential metrics to understand.
Cap Rate vs Yield
If you’re diving into real estate you might be wondering: what’s the difference between cap rate and yield?
- Cap Rate measures the property’s return based on its Net Operating Income (NOI) and market value. It’s a general indicator of performance.
- Yield, on the other hand, focuses on your total investment costs—including purchase price, rehab and fees. It’s specific to your actual return on the money you’ve spent.
In short, cap rate looks at market performance, while yield tells you how much you are earning on your investment. You might use cap rate when analyzing and comparing potential properties before purchasing to identify the best market value based on income.
Once you’ve bought in, you’ll use yield to evaluate your actual return.
What’s a Good Cap Rate?
A “good” cap rate depends on the property type, location and market conditions.
For example, a commercial property in a city center may generate high rental income, but a low cap rate. This is because it will have a higher market value, higher maintenance costs and higher taxes.
In contrast, a property on the city outskirts may have a low rental income, but a higher cap rate because of its lower purchase price.
Generally, cap rates between 5% and 10% are considered solid.
Lower cap rates typically indicate lower risk but slower returns, and higher cap rates reflecting higher risk with faster potential returns.
3 Methods to Calculate Your Cap Rate in Real Estate Investing
Method 1: Cap Rate Using Current Market Value
The most popular way to calculate the cap rate is by dividing the Net Operating Income (NOI) by the property’s current market value:
Cap Rate = (Net Operating Income / Current Market Value) x 100
Here’s how it works:
- Net Operating Income (NOI) is the annual income generated by the property (like rental income) after deducting expenses such as maintenance, property taxes, and management costs.
- Current Market Value is the property’s present-day value based on prevailing market rates.
This method is widely used because it reflects the property’s current performance and value, making it ideal for market comparisons.
Method 2: Cap Rate Using Purchase Price
Another method calculates the cap rate based on the original purchase price:
Cap Rate = (Net Operating Income / Purchase Price) x 100
While simple, this method can produce unrealistic results for older properties bought decades ago at much lower prices. It also doesn’t work for inherited properties with no purchase price.
That’s why, for a more accurate picture, most investors prefer using Method 1 instead.
Method 3: Adjusted Cap Rate for Occupancy Rates
Like any calculation made prior to purchase, the cap rate is only an estimation.
To get a more realistic cap rate it’s helpful to adjust your Net Operating Income (NOI) for a less-than-perfect occupancy rate. And then using this adjusted NOI in the calculation we say in Method 1.
NOI = (Gross Rental Income x Occupancy Rate) – Operating Expenses
For example, if you expect an 85% to 95% occupancy rate, this formula accounts for a 5–10% income loss due to vacancies. This approach provides a more conservative and realistic estimate, helping you make smarter investment decisions.
Cap Rate Comparison Example
Let’s say you’re thinking of purchasing two different rental properties. The first one is commuting distance to a medium-sized town and on the market for $400,000.
You grab the figures you need to estimate the NOI:
- Annual Gross Rental Income: $36,000
- Estimated Occupancy Rate: 90%
- Annual Expenses (taxes, maintenance, insurance): $6,000
You use Method 3 and Method 1 to calculate your NOI:
NOI = ($36,000 x 90%) – $6,000
NOI = $26,400
Now, calculate the Cap Rate:
Cap Rate = ($26,400 / $400,000) x 100
Cap Rate = 6.6%
Now let’s compare this to the second property. This property is much further out of town and costs $200,000—half the price of the first one—but comes with the following figures:
- Annual Gross Rental Income: $18,000
- Estimated Occupancy Rate: 90%
- Annual Expenses (taxes, maintenance, insurance): $4,000
Using Method 3 to calculate the NOI:
NOI = ($18,000 x 90%) – $4,000
NOI = $16,200
Now, calculate the Cap Rate:
Cap Rate = ($16,200 / $200,000) x 100
Cap Rate = 8.1%
At first glance, the 8.1% cap rate looks better than the 6.6% cap rate of the first property. But here’s the key:
A higher cap rate doesn’t mean you’ll earn more money—it just reflects a higher potential return relative to the cash investment. In this case, the second property generates $16,200 NOI, while the first property produces $26,400 NOI.
Furthermore, there could be more risk involved with the second property as it’s further out of town and may see lower demand.
Pros & Cons of Using Cap Rate
The cap rate is a valuable tool for real estate investors, but it’s not without limitations. Here’s a breakdown of its pros and cons:
Pros of Using Cap Rate
- Simple Property Comparisons: Cap rate is useful for comparing the relative value of similar real estate investments to determine which offers better potential returns.
- Stable Income Properties: Cap rate works best for properties that generate consistent rental income over the long term, such as buy-and-hold residential or commercial rentals.
- Investment Recovery Timeline: The cap rate can reveal the number of years it will take to recover the initial investment, giving a clear idea of long-term prospects.
Cons of Using Cap Rate
- Ignores Leverage and Future Cash Flows: Cap rate does not factor in mortgage payments, financing costs, or future cash flows from property improvements and appreciation.
- Ignores Renovation Costs: Expenses like refurbishment or renovation costs aren’t included, which could impact the true investment return.
- Assumes Perfect Income Stability: The cap rate relies on estimates of income and occupancy rates, which may not reflect reality.
- No Exact Profit Figures: Cap rate only provides an estimate of return; it won’t tell investors the exact amount they’ll earn.
How to Build a Buy-and-Hold Real Estate Portfolio…Without Having a Ton of Capital Up Front
At this point, you might be wondering: “What if I don’t have the capital to buy a property up front?”
You’re not alone. This is the case for a lot of real estate investors. That’s why the cap rate is typically used in commercial real estate by companies and investors with significant capital ready to deploy.
That said, you can still scale a real estate portfolio without starting with a ton of cash—and that’s exactly what Call Porter cofounder Ryan Dossey did.
The BRRRR Method
Ryan Dossey used the BRRRR method to close on $8 million worth of property (150 rental units) by the age of 26.
But here’s the key: he didn’t buy that $8 million outright. Instead, he started small, raised enough capital to purchase one rental property, and then rolled the capital into additional properties.
The BRRRR method—Buy, Rehab, Rent, Refinance, Repeat—is a proven strategy for scaling a buy-and-hold real estate portfolio step by step. Here’s how it works:
1. Buy
Start by purchasing an undervalued property. This is often a distressed property or one that needs work, allowing you to buy it below market value (and need a ton of capital upfront).
2. Rehab
Invest in renovations to increase the property’s value and its rental potential. This might include cosmetic upgrades, major repairs, or improving systems like HVAC or plumbing.
3. Rent
Once the property is rehabbed, rent it out to tenants. A stable rental income helps you cover operating expenses and generate positive cash flow.
4. Refinance
After the property is rented and generating income, refinance it based on its new, higher value. With a cash-out refinance, you can pull out equity (capital) from the property to fund your next deal.
5. Repeat
Take the capital you pulled out and roll it into another property—repeating the process to scale your portfolio. While you’re buying your second, third and fourth properties you continue to earn rental income from your original properties.
Over time, you build a sizable real estate portfolio.
Using Cap Rate to Analyze Properties
As you refinance and look for your next investment, use the cap rate to analyze potential properties. Here’s how:
- Calculate the property’s Net Operating Income (NOI) based on estimated rent and expenses.
- Divide the NOI by the property’s market value or purchase price to get the cap rate.
Since you may be buying up distressed or undervalued properties, your cap rate may be high. This is normal with the BRRRR method.
By combining the BRRRR method with cap rate analysis, you can strategically grow your portfolio—one property at a time—without needing massive capital up front. Just like Ryan Dossey, you can build a 7-figure real estate portfolio with focus, persistence, and the right strategy.
The Key to Building a 7-Figure Real Estate Portfolio: Getting Leads
In the video above, Ryan Dossey shares that the key to acquiring 150 rental units and building a 7-figure real estate portfolio is being able to source your own leads.
Generating real estate leads and securing off-market deals is crucial. It allows you to compare opportunities using tools like the cap rate and ultimately invest your cash where it will generate the highest returns.
But how do you generate enough leads?
And how do you sift through the bad leads to close quality deals—like Ryan did with 150 properties in just two years?
The answer lies in proven strategies like direct mail combined with Call Porter.
Call Porter is a U.S.-based call answering service built specifically for real estate investors. When motivated sellers call in, Call Porter’s trained professionals handle the conversations, pre-screening leads so you only focus on deals worth your time. No more missed calls, wasted hours, or poor-quality leads.
This system allows you to streamline lead generation, filter out unqualified sellers and close deals faster.
Ready to scale your real estate business and build a 7-figure portfolio?
Try Call Porter today and start turning your leads into profitable deals.