Difference Between Cap Rate and Discount Rate

Difference Between Cap Rate and Discount Rate: Key Differences Explained

If you’re evaluating a rental property, cap rate and discount rate are related but they do not answer the same question.

The Cap Rate measures a property’s NOI relative to its current value or purchase price. The discount rate is used to convert a series of expected future cash flows into today’s value through discounted cash flow analysis.

In simple terms:

Cap rate tells you how the property’s current or stabilized income compares with its value. Discount rate tells you how much future cash flows are worth today after accounting for time and required return.

This distinction matters when a landlord is deciding whether a rental property is fairly priced, comparing two investment properties, or building a multi-year investment model.

What Is the Difference Between Cap Rate and Discount Rate?

The biggest difference is time horizon and purpose.

A cap rate generally uses one year’s NOI:

Cap Rate = NOI ÷ Property Value

A discount rate is applied to future cash flows:

PV = CF ÷ (1 + r)ⁿ

where:

• PV = present value
• CF = future cash flow
• r = discount rate
• n = number of periods

A cap rate therefore provides a relatively simple, point-in-time income measure. A DCF uses a discount rate to analyze multiple future cash flows over a holding period. Altus Group makes the same distinction, describing capitalization as a point-in-time approach and DCF as a method that evaluates the property’s projected cash flows over the investment period.

Quick comparison

Factor	Cap Rate	Discount Rate
Main purpose	Capitalize income into value	Discount future cash flows
Typical horizon	One/stabilized income period	Multiple future periods
Main input	NOI and property value	Projected cash flows
Common method	Direct capitalization	DCF
Growth explicitly modeled?	Usually no	Yes
Cash-flow timing	Limited	Explicit
Exit value	Can be calculated using an exit cap	Discounted back to present
Risk consideration	Reflected indirectly in market pricing	Explicitly considered in required return
Typical use	Stabilized properties	Properties with changing cash flows

For a landlord, the important takeaway is that a 7% cap rate is not automatically a 7% investment return.

Mortgage payments, capital expenditures, future NOI, appreciation, selling costs, taxes and the eventual sale price can all change the actual investment outcome.

What Is a Cap Rate in Real Estate?

The capitalization rate, or cap rate, is a measure of a property’s annual NOI relative to its value.

The basic formula is:

Cap Rate = Annual NOI ÷ Property Value × 100

Suppose you purchase a rental property for $400,000 and its annual NOI is $28,000.

$28,000 ÷ $400,000 = 7%

The property has a 7% cap rate.

This means the property’s annual NOI equals 7% of its purchase price.

However, that does not mean the landlord receives a 7% cash return after financing.

For example, mortgage payments are not included in NOI. Neither are an owner’s income taxes or principal repayments. Current PropertyMetrics guidance likewise emphasizes that cap rate is based on NOI and should not automatically be interpreted as total investment return.

What goes into NOI?

Depending on the property and calculation method, NOI generally starts with property income and subtracts operating expenses.

Typical operating considerations include:

• Rent
• Other property income
• Vacancy and collection losses
• Property taxes
• Insurance
• Repairs
• Maintenance
• Utilities paid by the owner
• Property management
• Other operating expenses

NOI generally does not include:

• Mortgage principal
• Mortgage interest
• Owner income taxes
• Personal expenses
• Major capital expenditures in the conventional NOI calculation

The exact treatment can vary by valuation or underwriting methodology, so landlords should use a consistent definition when comparing properties.

How to Calculate Cap Rate: Formula and Example

The basic formula is:

Cap Rate = NOI ÷ Property Value

To estimate value from NOI:

Property Value = NOI ÷ Cap Rate

Example 1: Calculate the cap rate

Suppose a rental property has:

• Annual rental and other income: $48,000
• Operating expenses: $16,000
• NOI: $32,000
• Purchase price: $400,000

Then:

Cap Rate = $32,000 ÷ $400,000

Cap Rate = 8%

Example 2: Estimate property value

Suppose another property produces:

NOI = $36,000

Comparable properties indicate an appropriate cap rate of:

6%

Then:

Value = $36,000 ÷ 0.06

Value = $600,000

The calculation is simple, but the difficult part is deciding whether the NOI and cap rate are appropriate.

Why this matters for landlords

Two properties may both advertise an 8% cap rate, but that doesn’t necessarily mean they are equally attractive investments.

One might have:

• Stable tenants
• Newer systems
• Low expected capital expenses
• Strong rental demand

The other might have:

• Deferred maintenance
• High vacancy risk
• Upcoming roof replacement
• Uncertain rent growth

The headline cap rate does not tell the entire story.

What Is a Discount Rate in Real Estate?

A Discount Rate is the rate used to convert future cash flows into their present value.

The concept comes from the time value of money.

Receiving $10,000 today and receiving $10,000 five years from now are not economically identical because money available today can potentially be invested and future cash flows carry uncertainty.

In a rental-property DCF, you might forecast:

• Year 1 rental income
• Year 2 rental income
• Vacancy
• Operating expenses
• Repairs
• Capital expenditures
• NOI
• Sale proceeds
• Selling costs

The discount rate is then used to translate those future amounts into present dollars.

RICS defines the discount rate as the rate used to derive the NPV of expected future cash flows and notes that it commonly represents the property’s target or expected rate of return in investment analysis.

Example

Suppose you expect to receive $50,000 one year from now.

At an 8% discount rate:

PV = $50,000 ÷ 1.08

PV ≈ $46,296

So the present value of that future $50,000 is approximately $46,296 under an 8% discount rate.

The further into the future the cash flow occurs, the more periods of discounting may apply.

How to Calculate a Discount Rate in a DCF

Unlike a cap rate, there isn’t one universal formula that tells every landlord what discount rate to use.

A discount rate represents a required or target return appropriate to the investment and its risk.

One conceptual framework is:

Discount Rate ≈ Risk-Free Rate + Risk Premiums

The risk premium can reflect characteristics such as:

• Property type
• Location
• Tenant quality
• Vacancy risk
• Lease stability
• Expected growth
• Capital expenditure requirements
• Liquidity
• Market conditions
• Investment risk

RICS notes that discount rates can be supported by property-market or financial-market evidence and can incorporate a risk-free rate and risk premium; approaches can also include models such as CAPM or WACC depending on the valuation context.

For a small landlord, however, you should avoid pretending that a single formula produces a universally correct discount rate.

Instead, document your assumption and test how the property’s valuation changes when the rate changes.

Example

Assume your projected five-year cash flows produce a present value of $500,000 at a 7% discount rate.

If you increase the discount rate to 9%, the present value will generally decline, assuming everything else remains unchanged.

That’s why discount-rate sensitivity is so important.

Cap Rate vs. Discount Rate: Key Differences Compared

Question	Cap Rate	Discount Rate
What does it measure?	Income relative to value	Required return used to discount future cash flows
Main calculation	NOI ÷ value	PV of future cash flows
Time period	Usually one year/stabilized period	Entire projected holding period
Uses future cash flows?	Not explicitly	Yes
Models growth?	Usually implicit	Yes
Used for terminal value?	Yes, as an exit cap	No; it discounts terminal value
Used in DCF?	May help establish exit value	Core DCF input
Affected by risk?	Yes, through market pricing	Yes, explicitly through required return
Good for stabilized property?	Often useful	Can be useful
Good for changing cash flows?	Limited	Often more appropriate
Equals total investment return?	No	No

A simple way to remember it

Cap rate:
“What’s the property’s income yield relative to its value?”

Discount rate:
“What is the present value of the property’s future cash flows at my required return?”

Are Cap Rate and Discount Rate the Same?

No—not generally.

There are special circumstances where mathematics can make capitalization rate and discount rate equivalent.

RICS explains that under simplified assumptions involving constant income, no growth, and appropriate cash-flow timing, a yield can function as the discount rate. But those assumptions are often not appropriate for real-world investments with changing cash flows.

For a typical rental-property investment, cash flows can change because of:

• Rent increases
• Vacancy
• Lease turnover
• Repairs
• Property taxes
• Insurance
• Capital improvements
• Property appreciation
• Selling costs

That is why you should not automatically take a property’s cap rate and label it the discount rate.

Example

Suppose:

• Purchase price = $500,000
• NOI = $30,000
• Cap rate = 6%

The cap rate tells you:

$30,000 ÷ $500,000 = 6%

But suppose NOI is projected to grow by 3% annually.

Now the future income stream is different from today’s income.

A DCF can model that growth explicitly. The cap rate by itself cannot.

How Are Cap Rate and Discount Rate Related?

Cap rate and discount rate can be related through growth expectations.

Under a simplified constant-growth model:

Cap Rate ≈ Discount Rate − Growth Rate

Therefore:

Discount Rate ≈ Cap Rate + Growth Rate

For example:

• Cap rate = 6%
• Long-term growth = 2%

Then:

Discount rate ≈ 8%

This relationship is useful for understanding valuation theory, but it should not be treated as a universal rule.

RICS presents the simplified relationship between capitalization rate, target/discount rate and expected growth, while also showing that more complicated lease and growth patterns require a more detailed analysis.

• Explore More: https://calclandlord.com/commercial-property-valuation/

Why growth matters

Imagine two properties both have a 6% cap rate.

Property A is expected to have almost no NOI growth.

Property B is expected to experience sustained NOI growth.

The two properties can have different expected returns and values even though their initial cap rates are identical.

This is why a landlord should look beyond the first-year cap rate.

What Is the Gordon Growth Relationship Between Cap Rate and Discount Rate?

The Gordon Growth model helps explain the mathematical relationship.

A simplified growing-perpetuity formula is:

Value = CF₁ ÷ (r − g)

where:

• CF₁ = next-period cash flow
• r = discount rate
• g = long-term growth rate

Since:

Cap Rate = CF₁ ÷ Value

the relationship becomes:

Cap Rate = r − g

or:

r = Cap Rate + g

Example

Suppose:

• Next year’s NOI = $30,000
• Property value = $500,000
• Expected perpetual growth = 2%

First:

Cap Rate = $30,000 ÷ $500,000 = 6%

Then, under the simplified Gordon Growth assumptions:

Discount Rate ≈ 6% + 2% = 8%

Important limitation

Real rental properties rarely produce perfectly constant growth forever.

A property might have:

• 2% rent growth for several years
• a major lease renewal
• a vacancy period
• a large repair
• a property-tax increase
• changing insurance costs
• a different exit cap rate

RICS specifically cautions through its DCF examples that the simple cap-rate-plus-growth relationship depends on assumptions about the timing and pattern of income growth.

So use the Gordon Growth relationship as an intuition-building shortcut, not as a replacement for a detailed DCF when the cash flows are complicated.

How Do Cap Rates Affect Rental Property Value?

Cap rates and property values have an inverse relationship when NOI stays constant.

The formula is:

Property Value = NOI ÷ Cap Rate

Suppose a rental property has:

NOI = $40,000

Then:

Cap Rate	Implied Value
5%	$800,000
6%	$666,667
7%	$571,429
8%	$500,000
9%	$444,444
10%	$400,000

Notice what happens:

Higher cap rate → lower implied value

Lower cap rate → higher implied value

This doesn’t mean a lower cap rate automatically makes a property a better investment.

A lower cap rate may reflect stronger location, better tenants, lower perceived risk, better growth prospects, or other market characteristics.

Likewise, a higher cap rate can reflect greater risk or weaker expected income.

Current PropertyMetrics guidance emphasizes that cap rates reflect more than a simple interest-rate comparison and can incorporate property, market, growth, tenant and risk characteristics.

Landlord takeaway

When comparing properties, don’t ask only:

“Which one has the higher cap rate?”

Also ask:

• How reliable is the NOI?
• Is the NOI normalized?
• How much maintenance is coming?
• How stable are the tenants?
• What rent growth is realistic?
• What is the property’s vacancy history?
• What will the property be worth at exit?

How Does the Discount Rate Affect Property Value?

The discount rate has an inverse relationship with present value.

All else equal:

Higher discount rate → lower present value

Lower discount rate → higher present value

Suppose you expect to receive $100,000 five years from now.

At 6%:

PV = $100,000 ÷ (1.06)⁵

At 10%:

PV = $100,000 ÷ (1.10)⁵

The approximate values are:

• At 6%: $74,726
• At 10%: $62,092

The same future $100,000 has a lower present value when discounted at the higher rate.

Why landlords should care

Suppose you’re evaluating a property that depends heavily on future appreciation.

A DCF can expose how sensitive your valuation is to:

• Your discount rate
• Rent growth
• Vacancy
• Operating expenses
• Exit cap rate
• Sale price

This is much more informative than looking at a single cap rate.

Altus Group similarly notes that the discount rate is a core DCF input and that higher-risk properties generally warrant higher discount rates.

Cap Rate vs. Discount Rate vs. IRR and NPV

These four concepts are frequently mixed together, but they have different roles.

Cap rate

A cap rate is primarily a single-period income capitalization metric.

Cap Rate = NOI ÷ Value

Discount rate

A discount rate is a DCF assumption used to convert future cash flows to present value.

NPV

Net Present Value (NPV) compares the present value of future cash flows with the initial investment.

Conceptually:

NPV = Present Value of Future Cash Flows − Initial Investment

A positive NPV means the modeled future cash flows have greater present value than the initial investment at the selected discount rate.

IRR

Internal Rate of Return (IRR) is the rate that makes the investment’s NPV equal to zero for the specified cash-flow sequence.

Altus Group describes the relationship directly: the discount rate is an input into NPV analysis, while IRR is the rate at which NPV reaches zero.

The easiest comparison

Metric	Main Question
Cap rate	What is current/stabilized NOI relative to value?
Discount rate	What rate should discount future cash flows to present value?
NPV	How much value remains after discounting cash flows and subtracting investment?
IRR	What return is implied by the complete cash-flow stream?

Why this matters to landlords

Suppose two rentals both have an 8% cap rate.

That doesn’t guarantee that both have the same IRR.

One could have strong rent growth and appreciation.

The other could require major capital expenditures and have weak future income.

The initial cap rate is identical, but the complete investment cash flows can be very different.

Going-In Cap Rate vs. Exit Cap Rate in a DCF

A going-in cap rate describes the property’s income yield at acquisition.

An exit cap rate is used to estimate the property’s value at the end of the holding period.

Going-in cap rate

Going-In Cap Rate = Year-1 NOI ÷ Purchase Price

Suppose:

• Purchase price = $500,000
• Year-1 NOI = $35,000

Then:

$35,000 ÷ $500,000 = 7%

Exit value

Suppose year-five NOI is expected to be:

$45,000

and your assumed exit cap rate is:

7.5%

Then:

Exit Value = $45,000 ÷ 0.075

Exit Value = $600,000

That $600,000 is a future value, not today’s value.

To include it in a DCF, you discount the terminal value back to the present.

RICS calls the capitalization rate applied at the terminal date the exit yield and identifies terminal value as a key component of DCF analysis.

Why exit cap rate matters

A small change in the exit cap rate can substantially change terminal value.

For the same $45,000 NOI:

Exit Cap Rate	Exit Value
6%	$750,000
7%	$642,857
7.5%	$600,000
8%	$562,500
9%	$500,000

This is why landlords should not blindly assume that today’s cap rate will remain unchanged at sale.

Worked Rental Property Example: Cap Rate and Discount Rate

Let’s put the concepts together using a hypothetical U.S. rental property.

Assume:

• Purchase price: $400,000
• Year-1 gross rental income: $48,000
• Operating expenses: $16,000
• Year-1 NOI: $32,000
• Expected NOI growth: 3% annually
• Holding period: 5 years
• Exit cap rate: 7.5%
• Illustrative discount rate: 9%

These are hypothetical assumptions, not a recommendation or market forecast.

Step 1: Calculate the going-in cap rate

Cap Rate = $32,000 ÷ $400,000

Cap Rate = 8%

So the property has an 8% going-in cap rate based on these assumptions.

Step 2: Project NOI

With 3% annual NOI growth:

Year	Projected NOI
1	$32,000
2	$32,960
3	$33,949
4	$34,967
5	$36,016

Step 3: Estimate the exit value

Using year-five NOI and a 7.5% exit cap rate:

Exit Value = $36,016 ÷ 0.075

Exit Value ≈ $480,213

This is the estimated sale value before considering selling costs.

Step 4: Discount the future cash flows

The five annual NOI amounts and the terminal sale proceeds are future cash flows.

Each is discounted using:

PV = CF ÷ (1 + 0.09)ⁿ

For example, year-five NOI is discounted five periods:

PV of Year-5 NOI = $36,016 ÷ (1.09)⁵

The terminal value is also discounted for five periods.

Step 5: Include other investment cash flows

A real landlord analysis should also consider appropriate items such as:

• Vacancy
• Leasing costs
• Major repairs
• Capital expenditures
• Selling expenses
• Financing cash flows
• Taxes, depending on the purpose of the analysis

This is where a DCF becomes more informative than a simple cap-rate calculation.

What the example demonstrates

The 8% cap rate describes the relationship between current NOI and the $400,000 acquisition price.

The 9% discount rate is an illustrative required-return assumption used to discount future cash flows.

The 7.5% exit cap rate estimates the property’s terminal value.

Those three percentages perform different jobs.

Common Mistakes and Best Practices for Using Cap and Discount Rates

Understanding the formulas isn’t enough. The assumptions behind them matter just as much.

Mistake 1: Treating cap rate as total return

An 8% cap rate does not mean an investor will earn exactly 8%.

Actual investment results can differ because of:

• Financing
• NOI changes
• Appreciation
• Capital expenditures
• Selling costs
• Holding period

Best practice: Treat cap rate as one property-level valuation metric, not the entire investment return.

Mistake 2: Using gross rent instead of NOI

Cap rate normally uses NOI rather than gross scheduled rent.

Best practice: Normalize income and operating expenses before calculating cap rate.

Mistake 3: Ignoring vacancy

A property that appears profitable at 100% occupancy may have a very different NOI at realistic occupancy.

Best practice: Use a defensible vacancy and collection-loss assumption.

Mistake 4: Ignoring major capital expenditures

A building may have strong NOI while simultaneously needing a roof, HVAC system, parking lot or other major capital improvement.

Best practice: Keep NOI and capital-expenditure analysis conceptually separate and include appropriate capital needs in the broader investment model.

Mistake 5: Assuming cap rate equals discount rate

This is one of the most common conceptual errors.

Best practice: Ask whether you’re capitalizing one income period or discounting an entire future cash-flow stream.

Mistake 6: Using the Gordon Growth equation blindly

Cap Rate ≈ Discount Rate − Growth

is useful under simplified assumptions.

It isn’t a universal valuation shortcut for every rental property.

Best practice: Use a full DCF when cash flows, lease events, expenses or growth patterns are complicated.

Mistake 7: Ignoring exit assumptions

A DCF can be highly influenced by terminal value.

Best practice: Test multiple exit-cap-rate assumptions.

Mistake 8: Focusing on one percentage

A property shouldn’t be judged from cap rate alone.

Best practice: Review:

• Cap rate
• Cash flow
• Cash-on-cash return
• NOI
• Debt service
• DCF value
• NPV
• IRR
• Exit assumptions
• Capital expenditure requirements

The exact metrics needed depend on the investment question.

A Practical Landlord Decision Framework

When evaluating a rental property, move through the analysis in this order.

1. Normalize the income

Determine realistic:

• Rent
• Other income
• Vacancy
• Collection losses

2. Calculate NOI

Subtract appropriate operating expenses.

3. Calculate the going-in cap rate

Use:

NOI ÷ Purchase Price

4. Examine the property’s future

Ask:

• Will rent grow?
• Are expenses rising?
• Are leases expiring?
• Is major maintenance coming?
• Is vacancy likely to change?

5. Build future cash flows

Project the property’s income and expenses over the intended holding period.

6. Choose and document a discount-rate assumption

Consider the property’s risk and the purpose of the analysis.

7. Estimate terminal value

Use an appropriate exit cap-rate assumption.

8. Discount the cash flows

Calculate present values.

9. Evaluate NPV and IRR where appropriate

These can help you understand the investment’s modeled economics.

10. Run sensitivity analysis

Change important assumptions.

For example:

• Lower rent growth
• Higher vacancy
• Higher expenses
• Higher discount rate
• Higher exit cap rate
• Lower exit cap rate

If the investment only works under one optimistic scenario, that is important information.

People Also Ask

Conclusion

The Difference Between Cap Rate and Discount Rate becomes much easier to understand once you separate their purposes.

Cap rate is primarily a capitalization measure:

Cap Rate = NOI ÷ Property Value

It tells you how a property’s current or stabilized NOI compares with its value.

Discount rate is a DCF valuation input:

PV = Future Cash Flow ÷ (1 + Discount Rate)ⁿ

It helps convert future rental-property cash flows and terminal value into today’s dollars.

The two rates can be mathematically related under simplified growth assumptions:

Discount Rate ≈ Cap Rate + Growth Rate

But this relationship depends on assumptions about growth, timing, cash flows and terminal value. Professional valuation guidance specifically shows that more complex income patterns can make the simple relationship inadequate.

For a landlord, the most useful framework is:

Cap rate → current/stabilized income relative to value

Discount rate → present value of future cash flows

Exit cap rate → estimated value at the end of the holding period

NPV → value created or lost at a selected discount rate

IRR → return implied by the investment’s cash-flow stream

The biggest mistake is making an investment decision from one percentage alone. A rental property should be evaluated using realistic NOI, vacancy, expenses, capital expenditures, financing, growth assumptions and exit conditions.

For a simple property, start with NOI and cap rate. For a property whose future cash flows are expected to change materially, move toward a DCF and sensitivity analysis.

CalcLandlord’s Cap Rate Calculator would be the natural next step for checking the initial capitalization calculation, while a cash-flow or investment-return tool can help extend the analysis when those tools are available on the site.