How do you calculate a cap rate from your own property's books?
Cap rate is net operating income divided by the property's value. From your own books, take the last 12 months of the property's profit and loss, add back loan interest, depreciation and any improvements booked as expenses, subtract a management fee if you manage it yourself, and divide the result by a current value or an offer. Your book net income is not NOI, so skipping the adjustments gives a cap rate that is far too low.
The formula, and why your P&L is not ready yet
Cap rate = NOI / value. NOI is income from running the property minus the costs of running it. Your profit and loss, especially one built for Schedule E, also holds things NOI leaves out: mortgage interest, depreciation, and sometimes an improvement that was booked as a repair. It may also leave out a cost a buyer will insist on, such as a manager's fee you never pay because you do the work. So you adjust first. The full definition of NOI is in how to calculate NOI; this post starts from the books you already keep.
Step 1: pull the trailing 12 months
Run the property's profit and loss for the last 12 full months, not the calendar year, so it reflects current rents and costs. Use collected income, since that is what the building actually earned.
| Line in the books (made-up 16 unit building) | Last 12 months |
|---|---|
| Rent collected | $218,880 |
| Laundry income | $3,120 |
| Total income | $222,000 |
| Mortgage interest | $61,000 |
| Depreciation | $52,000 |
| Property taxes | $27,000 |
| Insurance | $12,600 |
| Utilities | $19,800 |
| Repairs (includes a $9,000 partial roof replacement) | $24,500 |
| Cleaning and maintenance | $6,200 |
| Legal and professional | $3,400 |
| Supplies | $1,900 |
| Auto and travel | $2,600 |
| Total expenses | $211,000 |
| Net income in the books | $11,000 |
Step 2: adjust from book income to NOI
| Adjustment | Why | Amount |
|---|---|---|
| Add back mortgage interest | NOI is before financing | +$61,000 |
| Add back depreciation | A tax deduction, not a cash operating cost | +$52,000 |
| Add back the roof work | An improvement, not a running cost; the IRS says improvements are capitalized | +$9,000 |
| Subtract a management fee | A buyer or lender assumes someone is paid to manage | -$13,320 (a made-up 6% of $222,000) |
Example for the made-up building, NOI is $11,000 plus $61,000 plus $52,000 plus $9,000 minus $13,320, which is $119,680. Check it the other way: operating expenses are $27,000 plus $12,600 plus $19,800 plus $15,500 of true repairs plus $6,200 plus $3,400 plus $1,900 plus $2,600 plus $13,320, or $102,320, and $222,000 minus $102,320 is $119,680.
The treatment of the roof follows the IRS rule in Publication 527 that improvements are capitalized and depreciated rather than deducted as repairs. If your books already keep improvements in their own account, this adjustment disappears.
Step 3: divide by a value
Example if a broker suggests the made-up building is worth $1,700,000, the cap rate is $119,680 divided by $1,700,000, about 7.04%. If the owner paid $1,500,000, the cap rate on the purchase price is $119,680 divided by $1,500,000, about 7.98%. Using book net income instead, $11,000 divided by $1,700,000 is about 0.65%, which says nothing useful.
Turn it around to estimate value: divide NOI by a cap rate. At 6.5%, $119,680 divided by 0.065 is about $1,841,000. That also shows why every dollar of NOI matters at sale: at 6.5%, each extra $1,000 of NOI adds about $15,385 of value ($1,000 divided by 0.065).
Reserves: show the number both ways
Some buyers and lenders subtract a yearly replacement reserve before computing cap rate. If you do, say so, because it changes the result.
Example with a made-up reserve of $300 per unit per year, 16 units take $4,800 off NOI, leaving $114,880. At a $1,700,000 value, the cap rate falls from about 7.04% to about 6.76% ($114,880 divided by $1,700,000).
How large a reserve to set is covered in capital reserves per unit.
Mistakes that distort a cap rate from your books
- Mixing properties. A cap rate is per building, so each needs its own P&L.
- Using scheduled rent instead of what was collected.
- Counting security deposits received as income.
- Leaving one-time items in, such as an insurance claim payout, without saying so.
- Comparing your number with a market cap rate that was computed a different way, for example with reserves.
How DoorKeeping helps
DoorKeeping keeps one set of books per property, with its own profit and loss and expense accounts mapped to Schedule E lines, so the trailing 12 months for one building is never mixed with another. You see every property together in the web app, and you can ask Claude or ChatGPT about units and the rent roll behind the income. The adjustments above, and the value you divide by, are still your call or your broker's; DoorKeeping gives no tax or investment advice.
Sources
- IRS, Publication 527, Residential Rental Property, read Oct 29, 2026
Questions
- Do you include mortgage payments when calculating cap rate?
- No. Cap rate uses NOI, which is before both interest and principal, so buildings can be compared regardless of how they are financed.
- Should I use the purchase price or current value for cap rate?
- Use current value or an offer to judge the building today. The purchase price gives your cap rate on cost, which is useful for judging how your purchase has done.
- Why is my cap rate so low when I calculate it from my tax return?
- Your return deducts interest and depreciation, which NOI excludes. Add them back, along with improvements booked as repairs.
- Is depreciation an operating expense for cap rate?
- No. It is a tax deduction for wear over time, not a cash cost of running the building, so it is added back.