Calculating Cap Rates for Smarter Property Decisions
Calculating cap rate is imperative for every investor, among the most important metrics in property investment is the capitalization rate, commonly known as the “cap rate.” This financial indicator helps you evaluate whether a rental property is profitable, overpriced, or a smart long-term opportunity.
Before diving into the formula, examples, and key considerations, it’s important to understand what a cap rate is and what it reveals about a potential rental investment. As Nairobi’s upmarket neighbourhoods continue evolving—Westlands, Riverside, Lavington, Kilimani, Kileleshwa, and Runda—investors increasingly rely on cap rates to avoid poor purchases and maximize returns.
Below are seven powerful steps to help you calculate cap rate accurately and use it wisely when evaluating rental properties.
1. What Is Cap Rate and Why Does It Matter?
Cap rate is a simple calculation used in real estate investing to determine the expected return on a property based on its net operating income (NOI). It does not include mortgage payments, making it an excellent tool for comparing properties regardless of financing.
Cap Rate Reveals:
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A property’s earning potential
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Market competitiveness
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Risk level
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Whether you’re overpaying for a rental property
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How your property compares to others in the same neighbourhood
Investors looking at Nairobi’s premium locations use cap rates to judge whether furnished apartments, long-term rentals, or serviced units offer the best returns.
2. The Exact Formula to Calculate Cap Rate
The formula is very straightforward:
Cap Rate = (Net Operating Income ÷ Property Value) × 100
Where:
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Net Operating Income (NOI) = Total Rental Income – Operating Expenses
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Property Value = The purchase price or current market value
This formula helps compare properties across different price ranges, neighbourhoods, and building types.
3. Determining Net Operating Income Accurately
Net operating income (NOI) is the most important part of the calculation. If you overestimate income or underestimate expenses, your cap rate will be misleading.
NOI Includes:
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Rental income (monthly or annual)
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Income from parking or service fees (if applicable)
Operating Expenses Include:
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Service charge
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Property management fees
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Maintenance
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Repairs
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Insurance
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Utilities (if covered by the landlord)
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Furnishing upkeep for serviced apartments
Example:
Annual rental income: KES 2,400,000
Operating expenses: KES 600,000
NOI = 2,400,000 – 600,000 = 1,800,000
You now have the first component required to calculate cap rate effectively.
4. Using Market Value Instead of Purchase Price
Many new investors mistakenly calculate cap rate only based on the purchase price. However, the market value often provides a more accurate picture of actual returns.
Market Value May Differ Because Of:
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Appreciation
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Changes in neighbourhood demand
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New developments nearby
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Shifts in rental pricing trends
Using current market value ensures you understand your true return—especially important in Nairobi’s rapidly evolving luxury markets.
5. What Is the Ideal Cap Rate in Nairobi’s Upmarket Areas?
Cap rates vary depending on location, property type, and rental strategy.
Typical Trends in Nairobi Upmarket Areas:
Serviced Apartments:
Cap Rate: 4% – 7%
High demand from corporate and international guests boosts returns.
Long-Term Furnished Units:
Cap Rate: 5% – 8%
Lower vacancy but also lower daily rates compared to short stays.
Unfurnished Long-Term Rentals:
Cap Rate: 3% – 6%
Stable occupancy, but lower income.
Rule of Thumb:
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Higher cap rates = higher risk (e.g., developing areas)
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Lower cap rates = lower risk (e.g., prime upmarket neighbourhoods)
Nairobi’s premium areas usually attract investors seeking long-term stability rather than extremely high returns.
6. Common Mistakes Investors Make When Calculating Cap Rate
Understanding what not to do protects you from making poor property decisions.
Mistake 1: Ignoring Operating Expenses
Leaving out recurring bills inflates your cap rate artificially.
Mistake 2: Using Gross Income Instead of NOI
This is a common rookie error—gross income is meaningless without expenses.
Mistake 3: Not Factoring Vacancy Rates
Even in upmarket areas, expect some vacancy between tenants.
Mistake 4: Relying Only on Cap Rate
Cap rate does NOT measure:
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Cash flow
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Appreciation
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Tax implications
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Financing costs
It’s only one piece of the investment puzzle.
Mistake 5: Comparing Different Property Types
You cannot compare:
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Serviced apartments vs. unfurnished units
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Flats vs. townhouses
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Studio units vs. 3-bedroom units
Cap rates must be compared within similar categories.
7. When Cap Rate Is Useful—and When It Isn’t
Cap rate is excellent for evaluating investment properties, but it’s not perfect.
Cap Rate Is Useful For:
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Comparing similar properties
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Analyzing rental income potential
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Understanding market trends
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Judging risk profiles
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Screening properties quickly
Cap Rate Is NOT Ideal For:
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Flipping properties
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Highly leveraged deals
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Properties with inconsistent income
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Complex mixed-use buildings
If you plan to flip a property or rely heavily on financing, cash-on-cash return may be a better metric than cap rate.
More on real estate returns:
https://www.biggerpockets.com/blog/cash-on-cash-return
Final Thoughts: Cap Rate Helps You Make Smarter Investment Decisions
Learning how to calculate cap rate accurately gives you the clarity, confidence, and insight needed to evaluate rental properties in Nairobi’s upmarket areas. Whether you are considering a serviced apartment in Westlands, a furnished unit in Riverside, or a long-term rental in Lavington, understanding cap rates ensures you avoid overpaying and maximize your investment returns.
Ready to Analyze Rental Investment Opportunities in Nairobi?
If you’re ready to evaluate properties using real numbers—not guesswork—our team at Realty Boris can help you calculate returns, compare neighbourhoods, and identify high-performance investment properties.
