Cap rate, short for capitalization rate, is a property's net operating income divided by its value or purchase price, expressed as a percentage. It represents the unlevered annual yield a buyer earns at the current price. Cap rate is the standard shorthand for how commercial real estate is priced, because it converts one year of income into an estimate of value.
How Is Cap Rate Calculated?
Cap rate is calculated by dividing net operating income by property value. The formula is Cap Rate = NOI / Property Value. Rearranged, Property Value = NOI / Cap Rate, which is the income capitalization approach to valuation. A $1,000,000 NOI at a 5% cap rate implies a $20,000,000 value.
The relationship between cap rate and value is inverse. When cap rates compress, values rise; when they expand, values fall, even with NOI held constant. Per Wall Street Prep, if a market cap rate moves from 8% to 6% while NOI stays at $80,000, implied value rises from $1,000,000 to about $1,333,000. This is why cap rate movement, not just rent growth, drives so much of the value change in a cycle.
Known values | Solve for | Formula |
NOI and value | Cap rate | Cap Rate = NOI / Value |
NOI and cap rate | Value | Value = NOI / Cap Rate |
Value and cap rate | NOI | NOI = Value x Cap Rate |
A higher cap rate signals higher expected return and, usually, higher perceived risk; a lower cap rate signals a safer, more sought-after asset priced richly. That single number encodes the market's view of risk and growth for a given property type and location.
Why Cap Rate Matters
Cap rate matters because it is how the market prices income property and how one asset is compared to another. A stabilized building trading at a 5% cap and an identical one at a 7% cap are being valued very differently, and the gap reflects location, tenant quality, and growth expectations more than the buildings themselves.
Cap rates vary widely by property type and market. In CBRE's U.S. Cap Rate Survey for H2 2025, based on roughly 3,600 estimates from more than 200 professionals across 50-plus markets, prime multifamily and industrial assets in strong Sun Belt and coastal markets carried Class A stabilized cap rates broadly in the high-4% to mid-6% range, while stabilized downtown office spanned a far wider band, from the mid-5% range in select markets to double digits in weaker ones. CBRE reported that all-property cap rates held steady in H2 2025 and that transaction volume rose about 19% for the year, with most respondents believing rates had reached a cyclical peak.
Small cap rate moves carry large value consequences. A 50 basis point shift, from 5.5% to 5.0%, raises the value of a $1,000,000 NOI asset from about $18,180,000 to $20,000,000, a swing near 10% with no change in the income. Underwriting the exit cap rate is therefore one of the most consequential assumptions in any hold-period model.
Example
An investor evaluates a stabilized retail center with $850,000 in net operating income, offered at $14,166,667. Dividing NOI by price gives the going-in cap rate. The table shows the calculation and how the same NOI values out at three different cap rates.
Cap rate | Calculation | Implied value |
Offer price | $850,000 / $14,166,667 | 6.00% |
5.50% | $850,000 / 0.0550 | $15,454,545 |
6.00% | $850,000 / 0.0600 | $14,166,667 |
6.50% | $850,000 / 0.0650 | $13,076,923 |
At the 6.00% offer, the buyer earns a 6% unlevered yield in year one. If the buyer believes the market cap rate for this asset is 5.50%, the property is worth about $15,450,000 and the offer looks attractive. If the correct market cap is 6.50%, fair value is closer to $13,080,000 and the offer is roughly $1,090,000 rich. The entire disagreement lives in fifty basis points of cap rate.
Variations and Edge Cases
Cap rate is not one number: the label depends on which NOI and which point in the hold it describes. Going-in and exit cap rates, stabilized versus in-place, and nominal versus effective yields all travel under the word "cap rate," so the term alone does not tell you what was measured. The table separates the common variants.
Variant | Meaning |
Going-in cap rate | Year-one NOI divided by purchase price; the entry yield |
Exit (terminal) cap rate | Assumed cap rate at sale; drives the reversion value in a DCF |
Stabilized cap rate | Based on NOI once the property reaches market occupancy and rents |
Trailing vs forward | Cap rate on last-twelve-month NOI versus next-year forecast NOI |
Effective cap rate | Adjusts for reserves and capital items excluded from headline NOI |
The frequent mistake is comparing a going-in cap on proforma NOI against a trailing cap on in-place NOI. They can differ by a full point on the same asset. A cap rate is only meaningful paired with the exact NOI that produced it.
Cap Rate vs Cash-on-Cash Return
Cap rate is often confused with cash-on-cash return, but they answer different questions. Cap rate is unlevered: NOI divided by property value, ignoring any loan. Cash-on-cash return is levered: annual pre-tax cash flow after debt service, divided by the equity invested. Cap rate prices the asset; cash-on-cash measures the return to the borrower's cash.
Because financing amplifies returns, a 6% cap asset can produce a double-digit cash-on-cash return with favorable leverage, or a negative one if the loan constant exceeds the cap rate. Cap rate describes the property; cash-on-cash describes the deal structure on top of it.
Frequently Asked Questions
What is a good cap rate in commercial real estate?A good cap rate depends on property type, market, and risk. Lower cap rates, such as the high-4% to 5% range CBRE reported for prime multifamily and industrial in strong 2025 markets, signal safer assets, while higher cap rates offer more yield for more risk. There is no single "good" number across the market.
Is a higher or lower cap rate better?A lower cap rate means a higher price for the same income and usually a safer asset, which benefits sellers. A higher cap rate means more yield and often more risk, which benefits buyers seeking return. Whether higher or lower is "better" depends on which side of the trade you are on.
How does cap rate relate to property value?Cap rate and value are inversely related through the formula Value = NOI / Cap Rate. When cap rates fall, values rise, and when cap rates rise, values fall, even if NOI is unchanged. This is why cap rate movement drives much of the value change over a market cycle.
Related Terms
Net Operating Income
Going-In Cap Rate
Exit Cap Rate
Income Approach
Cash-on-Cash Return