Cap Rate (Capitalization Rate)
The ratio of a property's Net Operating Income to its market value, expressed as a percentage. Represents unlevered return — what you'd earn with no mortgage. STR cap rates typically run 8–14%, vs 4–6% for long-term rentals.
Definition
What is Cap Rate (Capitalization Rate)?
Cap rate (capitalization rate) is the ratio of a property's Net Operating Income (NOI) to its current market value or acquisition price, expressed as a percentage. It represents the unlevered return on a real estate investment — what you would earn if you owned the property outright with no mortgage. A $500,000 property generating $45,000 in NOI has a 9% cap rate. Cap rate is the most widely used shorthand for comparing investment properties independent of financing structure.
Short-term rentals routinely achieve cap rates of 8–14% in strong markets, compared to 4–6% for long-term rentals on the same property. This spread is a primary reason investors convert properties to STR — the same asset often generates 2–3x the NOI under a vacation rental model versus a traditional lease. However, cap rates are highly sensitive to the accuracy of revenue and expense assumptions. Inflated revenue projections or understated expenses can make a property appear to have a much higher cap rate than it will actually deliver.
One important nuance: cap rate ignores financing. Two investors buying the same 8% cap rate property with different amounts of leverage will have very different cash-on-cash returns. Cap rate is most useful as a market-level comparison tool. When Chalet shows high cap rates in a market, it signals that the STR revenue premium is large relative to local property prices — an attractive entry signal for investors.
Formula
Cap Rate = (Net Operating Income ÷ Property Value) × 100
Real-world example
Scenario
A 3-bedroom cabin in the Smoky Mountains purchased for $420,000. Annual gross rental revenue: $74,000. Annual operating expenses: $22,000.
Calculation
NOI = $74,000 − $22,000 = $52,000. Cap Rate = ($52,000 ÷ $420,000) × 100 = 12.4%.
Result
A 12.4% cap rate is strong. For comparison: the same property as a long-term rental at $2,200/month generates roughly $26,400 NOI (after expenses), yielding a 6.3% cap rate — half as much. The STR model nearly doubles the income per dollar of asset value.
Why it matters for STR investors
Cap rate is the fastest way to rank and compare investment opportunities. When evaluating multiple markets or properties, cap rate lets you quickly identify which ones generate the most income per dollar of value — before spending time on deep due diligence. A 5% cap rate market and a 12% cap rate market are fundamentally different investment environments.
Key points
- Excludes mortgage payments — makes comparisons independent of financing
- STR cap rates are typically 2–5% higher than LTR cap rates for the same property
- Higher cap rate = more income per dollar of property value
- Does not capture appreciation, equity paydown, or tax benefits
- Accuracy depends entirely on realistic NOI assumptions — garbage in, garbage out
- Use to compare markets; use cash-on-cash return to evaluate your actual investor return
Related terms
