Head-to-head
Rental Yield vs Cap Rate
Both divide a property's income by its price. The difference is which income. Rental yield usually means the rent divided by the value, and gross yield ignores everything that eats into rent. Cap rate means net operating income — rent after vacancy and operating expenses — divided by price.
That makes gross yield a screening number and cap rate a pricing number. Gross yield is fast, comparable and almost always flattering. Cap rate is what an appraiser or a buyer uses to compare a property against others in the same market, because it is stated on the same basis for everyone.
Net rental yield sits in between by name and lands on the cap rate by arithmetic. Once you deduct vacancy and operating expenses from rent you have net operating income, and net operating income over value is the cap rate. The two are not rivals; they are the same calculation under different names. The real trap is comparing a gross yield against a market cap rate and concluding the deal is better than it is. A 6.60% headline set against a 3.87% market cap rate looks like a bargain, and it is only a different measurement of the same property.
Rental yield
How To Calculate Rental Yield
Rental yield is the return a property produces before financing, and the gap between the gross and net figures is where most landlords discover their real return.
Cap rate
How To Calculate Cap Rate
The capitalization rate is the return a property would throw off if you owned it outright. Net operating income divided by value, with the mortgage left out of the picture entirely.
How They Differ
| Attribute | Rental yield | Cap rate |
|---|---|---|
| Numerator | Annual rent, usually gross | Net operating income |
| Vacancy | Ignored | Deducted |
| Operating expenses | Ignored | Deducted |
| Mortgage payment | Ignored | Ignored |
| Typical use | Quick screen and listing headline | Pricing and valuation |
| Who quotes it | Agents and listing sites | Appraisers, lenders, institutional buyers |
| On the worked example | 6.60% | 3.87% |
| What moves it | Rent and price | Rent, vacancy, expenses and price |
| Net version of the same thing | Net yield, after costs | Already net — it is the same number |
| Best for comparing | Similar properties in one market | Different properties, and different markets |
The Same Numbers, Both Ways
$400,000 property, $2,200 a month rent, 5% vacancy, $9,600 a year of operating expenses, bought without a mortgage.
- Property value
- $400,000
- Monthly rent
- $2,200
- Vacancy rate
- 5%
- Annual operating expenses
- $9,600
| Line | Rental yield | Cap rate |
|---|---|---|
| Annual rent | $26,400 | $26,400 |
| Vacancy loss | Ignored | -$1,320 |
| Operating expenses | Ignored | -$9,600 |
| Income used | $26,400 | $15,480 |
| Divided by value | $400,000 | $400,000 |
| Result | 6.60% | 3.87% |
| Net yield on the same basis | 3.87% | 3.87% |
Gross yield is 6.60% and the cap rate is 3.87% on the same $400,000 property. The 2.73-point gap is $1,320 of vacancy and $9,600 of operating expenses. Net yield comes out at 3.87% — identical to the cap rate, because after those deductions both divide the same $15,480 by the same $400,000.
When To Use Each
Rental yield
- You are scanning listings and need one number that compares rent to asking price at a glance.
- You are explaining a deal to a buyer who wants the headline figure agents quote.
- You are checking whether rent covers a mortgage, where a gross figure is only a first filter.
Cap rate
- You are valuing a property against others in the same market on a like-for-like basis.
- You are deciding between markets where expense ratios and vacancy rates differ sharply.
- You are borrowing against the property and the lender asks for net operating income.
Common Questions
Is cap rate the same as net rental yield?
Arithmetically yes, provided both deduct the same costs. Cap rate is net operating income over price; net rental yield is rent minus costs over value. Feed them the same numbers and they return the same percentage, which is why comparing a gross yield to a cap rate is the mistake worth avoiding.
Should the mortgage payment be deducted?
No, for either measure. Cap rate is deliberately unlevered so that properties can be compared regardless of how the buyer finances them. Rental yield is also usually quoted before financing. If you want a levered figure you are calculating cash-on-cash return, which is a different number.
What is a good cap rate?
It depends entirely on the market and the asset. A 3.87% cap rate in a low-risk, high-growth city and a 9% cap rate in a declining one can both be fair prices. The cap rate is a summary of what buyers will pay for a dollar of net operating income, not a score.
Why does gross yield overstate the return so much?
Because rent is not income until vacancy and operating costs are paid. In the worked example, a 5% vacancy rate and $9,600 of expenses turn 6.60% into 3.87% — a 41% reduction. Older properties with higher maintenance loads erode it further.
Does a higher price to rent ratio mean a worse investment?
It means you are paying more years of rent for the property, which is the same information as a lower gross yield expressed differently. Whether that is bad depends on what you expect rents and prices to do next.
More Comparisons
- Down Payment vs Loan-to-Value
A $400,000 house with $80,000 down is 20% down and 80% LTV — the same fact twice. Put 5% down instead and the loan grows to $380,000, the payment rises $379.24 a month, and mortgage insurance usually arrives with it.
- ROI vs CAGR
ROI measures the whole return; CAGR turns it into a compound annual rate. A 100% return over five years is 20% a year by division but 14.87% a year in reality.
- Break-Even vs Payback Period
With $120,000 of fixed costs and $16 of contribution per unit, break-even is 7,500 units a year. The $300,000 machine behind them takes 7.5 years to repay at 10,000 units. Break-even asks how much you must sell, payback asks how long you wait.
Sources
- Capitalization rate — definition and use in valuation — Wikipedia
- Capitalization rate — how investors price income property — Corporate Finance Institute
- Housing prices — cross-country statistics — OECD
Both methods sit in Finance.