Mortgage Glossary
Cap Rate (Capitalization Rate)
Net Operating Income divided by Property Value, expressed as a percentage. The standard unleveraged-return metric.
What is Cap Rate?
Cap rate (short for capitalization rate) measures the unleveraged annual return on a real estate asset. It tells an investor what percentage of the purchase price the property earns each year in net operating income, before financing.
Cap Rate = Net Operating Income ÷ Property Value
Net Operating Income (NOI) is annual gross rents minus operating expenses — property taxes, insurance, property management, repairs and maintenance, HOA dues, and a vacancy reserve. Critically, NOI is calculated before mortgage payments and income taxes, which is why cap rate is an unleveraged metric.
A higher cap rate generally signals higher yield but often higher risk (older property, weaker market, vacancy concerns). A lower cap rate signals a more competitive, in-demand market where investors accept lower yields in exchange for appreciation potential and stability.
How Cap Rate applies at Total Quality Lending
Total Quality Lending does not underwrite DSCR loans on cap rate — we use DSCR (rents divided by PITIA), which already factors in the specific mortgage payment, taxes, and insurance for the deal. Cap rate is the investor’s tool for comparing properties before financing; DSCR is the lender’s tool for sizing the loan after financing is on the table.
That said, savvy investors should run both numbers. Cap rate tells you whether the property is fundamentally sound at the asking price. DSCR tells you whether the specific financing structure cash-flows. A property can have a strong cap rate and still fail DSCR if leverage is too high, and vice versa.
FAQs
How is cap rate calculated?
Cap Rate = Net Operating Income (NOI) divided by Property Value, expressed as a percentage. NOI is annual gross rents minus operating expenses (taxes, insurance, management, repairs, HOA, vacancy reserve) — but BEFORE mortgage payments and income taxes.
What's a good cap rate for a rental property?
It depends entirely on the market. In high-demand metros like Austin, Nashville, or coastal California, cap rates of 4–6% are common because property values are bid up. In secondary markets like Indianapolis, Memphis, or upstate New York, 7–10% cap rates are achievable. There is no universal threshold.
Does TQL use cap rate to underwrite a DSCR loan?
No. TQL DSCR loans underwrite on DSCR (rents divided by PITIA), not cap rate. Cap rate is a property-level investment metric that ignores financing, so it's most useful for investors comparing deals — not for lenders sizing loans.