Two buildings throw off an identical $1 million in net operating income. One sits in a gateway metro, the other in a small city three hours from the nearest institutional buyer. The first is worth roughly $18 million. The second is worth roughly $12 million. Nothing about the income explains the gap. The gap is the cap rate, and cap rate by market tier is the mechanism that prices the same NOI differently across cities. A cap rate is not a property of the building. It is the market's price for the risk and illiquidity of owning that income stream in that place.
The uncomfortable implication is that most of what looks like a "better deal" in a secondary or tertiary market is compensation for a thinner exit, not free yield.
Key Takeaways
Cap rate by market tier can make the same NOI worth 25 to 35 percent more in a primary market than in a tertiary one. The difference is priced by liquidity and risk premium, not by the income.
A cap rate is a yield, so a higher cap rate means a lower price. Tertiary markets trade at higher cap rates because buyers demand a liquidity premium for a thinner exit.
The Federal Reserve treats illiquidity as a cost investors must be paid to bear. Real estate's illiquidity translates directly into a higher required return in markets where buyers are scarce.
CBRE's U.S. Cap Rate Survey, now in its 17th year, reported that yields stabilized across major sectors in the second half of 2025. The tier spread between gateway and small metros persists through every phase of the cycle.
Underwriting a secondary or tertiary asset at a primary-market cap rate imports a liquidity the asset does not have and overstates its value.
Why does the same NOI get priced differently across markets?
The same NOI gets priced differently because value is NOI divided by the cap rate, and the cap rate carries a market-specific risk premium. Two identical income streams in different cities are not identical assets: one is easy to sell and finance, the other is not. Buyers price that difference into the yield they demand, so the cheaper-to-exit market commands a lower cap rate and a higher price.
A cap rate is a yield, and yields move inverse to price. When a market trades at a lower cap rate, the same dollar of income buys a higher valuation. Gateway markets like New York, Los Angeles, and Chicago trade at the lowest cap rates in the country because they offer the deepest buyer pools, the most active lenders, and the shortest time to sell. That liquidity is worth paying for, so it compresses the yield.
The Federal Reserve frames the underlying logic plainly in its research on market liquidity: illiquidity is a cost, and investors demand higher expected returns to hold assets they cannot convert to cash quickly or at a predictable price. Education sources such as Wall Street Prep describe the same effect as an illiquidity discount, where an otherwise identical asset is marked down until its yield compensates the buyer for accepting a slower, less certain exit. In a thin market, that discount shows up as a wider cap rate.
How much does the cap rate vary by market tier?
Cap rate spreads between tiers are wide and persistent. Representative estimates put primary markets in the range of 4.5 to 6.0 percent, secondary markets 75 to 175 basis points higher, and tertiary markets 200 basis points or more above the primary baseline. The exact numbers move with the cycle, but the ordering does not: liquidity is always priced.
Market tier is usually defined by population and institutional depth. Primary markets carry populations above roughly one million and the deepest capital pools. Secondary markets run in the 250,000 to one million range. Tertiary markets sit below that, with the thinnest buyer and lender base. The table below shows a representative structure, framed as estimates rather than survey figures, so treat the ranges as directional.
Market tier | Profile | Representative cap rate range | Spread vs primary | Liquidity signal |
|---|---|---|---|---|
Primary | Gateway metros, 1M+ population, deep institutional capital | 4.5% to 6.0% | Baseline | Large buyer pool, active lenders, fast sale |
Secondary | Mid-size metros, 250K to 1M population | 6.0% to 7.5% | +75 to 175 bps | Moderate buyer pool, selective financing |
Tertiary | Small metros, under 250K population | 7.5% to 9.5% | +200 to 350 bps | Thin buyer pool, longer time to sell |
CBRE's U.S. Cap Rate Survey, which has run for 17 years and draws on thousands of estimates across more than 50 markets, reported that cap rates stabilized across major sectors in the second half of 2025, with most institutional investors believing yields had reached a cyclical high. CBRE Investment Management separately noted the cap rate spread over the 10-year Treasury sat near 172 basis points in the third quarter of 2025, in roughly the 24th percentile of its range since 1965. Those are aggregate figures. The tier spread sits on top of them, so a tertiary asset carries both the market-wide risk premium and its own liquidity premium.
What is a $1M NOI worth at different cap rates by tier?
The same $1 million NOI is worth about $18.2 million at a 5.5 percent primary-market cap rate, about $14.8 million at a 6.75 percent secondary-market cap rate, and about $12.5 million at an 8.0 percent tertiary-market cap rate. The income never changes. The valuation swings by nearly $5.7 million, or roughly 31 percent, purely on the cap rate the market assigns to that location.
The arithmetic is worth walking through, because it is the whole argument:
Market tier | NOI | Value (NOI / cap rate) | Value vs primary | |
|---|---|---|---|---|
Primary | 1,000,000 | 5.50% | 18,181,818 | Baseline |
Secondary | 1,000,000 | 6.75% | 14,814,815 | -18.5% |
Tertiary | 1,000,000 | 8.00% | 12,500,000 | -31.3% |
Check the math: 1,000,000 divided by 0.055 equals 18,181,818. 1,000,000 divided by 0.0675 equals 14,814,815. 1,000,000 divided by 0.08 equals 12,500,000. The primary asset is worth $5,681,818 more than the tertiary one on identical income. That $5.7 million is not a reward for better real estate. It is the market paying for a deeper, faster, more certain exit.
Read the same table the other way and the tertiary buyer's logic appears. A buyer who pays 8.0 percent instead of 5.5 percent is not overpaying for yield: that buyer is demanding 250 basis points of extra return to be compensated for a market where the next sale may take longer, draw fewer bidders, and clear at a wider spread.
How should you underwrite cap rate by market tier without overpaying?
Underwrite each market to its own cap rate, and never lift a gateway yield onto a small-metro asset. The fastest way to overpay in a secondary or tertiary market is to model an exit cap borrowed from a primary comp set. The exit has to reflect the buyer pool that will actually exist when you sell, not the one that exists in a city you are not buying in.
Three disciplines follow from the tier structure:
Anchor the exit cap to the subject market's own liquidity. If comparable tertiary assets trade at 8 percent, an underwriting model that assumes a 6.5 percent exit is booking a liquidity that the market has never offered. Submarket data beats metro averages here, a point developed in why the submarket beats the metro in every underwriting decision.
Do not assume the tier spread compresses. The spread between primary and tertiary yields widens in stress, when capital retreats to liquid markets first. The Federal Reserve notes that liquidity premiums surge during periods of market stress, so the illiquid market reprices hardest exactly when you may need to sell.
Separate the risk premium from the yield. A high going-in cap rate in a tertiary market is not alpha. It is the price of a risk you are accepting. This is the same discipline that applies to exit assumptions in a higher-rate world where cap rate compression is over.
The operator who internalizes cap rate by market tier stops reading a high cap rate as a discount and starts reading it as a disclosure. The market is telling you what it thinks the exit is worth.
Frequently Asked Questions
What is a good cap rate for a secondary market?
There is no single good number, because a cap rate is relative to the market's liquidity and risk. Secondary markets typically trade 75 to 175 basis points above primary-market yields. A cap rate is defensible when it compensates you for the specific buyer pool, lender depth, and exit timeline of that submarket, not when it simply looks high.
Does a higher cap rate mean a better deal?
No. A higher cap rate means a lower price for a given income, but it usually also means higher risk or lower liquidity. In tertiary markets the extra yield is compensation for a thinner exit, not free return. The deal is only better if the operational upside or hold economics justify accepting that risk premium.
Can a tertiary market ever price tighter than a primary one?
Rarely, and only for a specific asset, not a whole market. A tertiary property with a long lease to a strong credit tenant can trade near primary-market yields, because the income certainty offsets the location's illiquidity. The tenant credit, not the geography, is doing the work in that case.
Conclusion
Cap rate by market tier is the reason identical income streams carry different price tags across cities. Value is NOI divided by a yield, and that yield is the market's price for liquidity and risk in a specific place. A $1 million NOI worth $18 million in a gateway market and $12.5 million in a small metro is not a valuation error. It is the liquidity premium, quantified. The operator's job is to underwrite each asset to the market that will actually price it at exit, treat a wide cap rate as a warning label rather than a bargain, and refuse to import a liquidity that the market has never offered.