noun · /kap reɪt/
Cap Rate
Also known as: Capitalization Rate, Cap
Definition
Cap rate (capitalization rate) is the ratio of a property's Net Operating Income (NOI) to its current market value, expressed as a percentage. It's one of the most important metrics in commercial real estate investing, used to quickly compare the relative value of different investment properties and estimate potential returns.
Formula
Cap Rate = NOI ÷ Property Value × 100
Where NOI = Gross Operating Income − Operating Expenses (excluding debt service)
Cap Rate Example
Consider a 20-unit apartment building with the following financials:
Annual Income
- Gross Rental Income$240,000
- Other Income (laundry, parking)$12,000
- Less: Vacancy (5%)−$12,600
- Effective Gross Income$239,400
Operating Expenses
- Property Taxes$28,000
- Insurance$8,000
- Utilities$18,000
- Repairs & Maintenance$15,000
- Property Management (8%)$19,152
- Total Expenses$88,152
NOI
$151,248
($239,400 − $88,152)
Property Value
$2,400,000
Cap Rate
6.30%
($151,248 ÷ $2,400,000)
What is a Good Cap Rate?
There's no universal "good" cap rate—it depends on property type, location, condition, and your risk tolerance. Here are typical ranges by asset class (as of 2024):
Multifamily
4.5% – 7.0%Class A urban properties trade at lower cap rates (4-5%), while Class B/C suburban properties see 5.5-7%+.
Industrial
5.0% – 7.5%Logistics and distribution centers in major markets command premium (lower) cap rates due to e-commerce demand.
Office
6.0% – 9.0%Post-pandemic uncertainty has pushed office cap rates higher. Class A CBD properties still trade tighter than suburban.
Retail
5.5% – 8.5%NNN single-tenant retail with credit tenants trades at lower cap rates; strip centers and malls are higher.
Self-Storage
5.5% – 8.0%Stabilized, well-located facilities in strong markets trade at the lower end; older or lease-up properties at higher cap rates.
Hospitality
7.0% – 10.0%Hotels carry operational risk and volatility, commanding higher cap rates. Select-service trades tighter than full-service.
Important Context
Cap rates are inversely related to interest rates. When interest rates rise, cap rates generally expand (increase), putting downward pressure on property values. Always consider the current interest rate environment when evaluating cap rates.
Cap Rate vs. Other Return Metrics
| Metric | Formula | Includes Debt? | Best For |
|---|---|---|---|
| Cap Rate | NOI ÷ Value | No | Comparing unlevered property values |
| Cash-on-Cash | Cash Flow ÷ Cash Invested | Yes | Measuring return on your actual equity |
| IRR | Discount rate where NPV = 0 | Yes | Total return over holding period |
| Equity Multiple | Total Distributions ÷ Equity | Yes | Total profit multiple on investment |
Cap rate is useful for quick comparisons but doesn't tell the whole story. Always analyze multiple metrics when evaluating an investment.
How Cap Rate is Used
Property Valuation
Rearranging the formula: Value = NOI ÷ Cap Rate. If you know the market cap rate, you can estimate property value from its NOI.
Comparing Properties
Cap rate normalizes property values regardless of size, allowing apples-to-apples comparison between a $1M and $10M property.
Market Analysis
Tracking cap rate trends reveals market sentiment. Compressing cap rates indicate increased investor demand; expanding cap rates suggest caution.
Exit Planning
Value-add investors improve NOI and/or sell at a lower (better) cap rate. The difference between entry and exit cap rates significantly impacts total returns.
Limitations of Cap Rate
Ignores Financing
Cap rate is an unlevered metric—it doesn't account for how you finance the purchase. Two properties with identical cap rates can have very different returns depending on loan terms.
Point-in-Time Snapshot
Cap rate uses current NOI and doesn't reflect future income growth, lease rollovers, or capital expenditure needs. A property with expiring below-market leases may look worse than it is.
NOI Inconsistencies
There's no universal standard for calculating NOI. Some brokers exclude management fees or reserves, inflating NOI and making the cap rate look better. Always verify the NOI calculation.
Not Applicable to All Properties
Cap rate doesn't work well for development sites, vacant properties, or assets being repositioned where current NOI doesn't reflect stabilized performance.
Calculate Cap Rate Instantly
Use our free cap rate calculator to analyze property values, NOI, and see sensitivity analysis across different cap rate scenarios.