How do you calculate the cap rate?

Divide net operating income by the purchase price. Net operating income is annual rent minus vacancy and operating expenses such as taxes, insurance, maintenance, reserves and management, before any mortgage payment. A property with $30,000 of NOI priced at $500,000 has a 6% cap rate.

Start with gross scheduled rent, subtract 5 to 8% for vacancy, then subtract every cost of running the property. Include management at 8 to 10% even if you self-manage and a capital reserve of 5 to 10% for the roof and systems, because a buyer or appraiser will. Leave out the mortgage, depreciation and income taxes.

The result divided by price, times 100, is the cap rate. The most common error is leaving out vacancy, management and reserves, which adds one to two points. A listing that quotes rent and price but no expenses is inviting you to make that error.