Capitalization rate — cap rate — is how commercial real estate investors, appraisers, and institutional buyers value income-producing property. It strips out financing and measures the property's underlying income performance. Once you understand cap rate, you can evaluate any deal in seconds and spot overpriced listings immediately.

The Cap Rate Formula

Cap Rate = Net Operating Income (NOI) / Property Value × 100

Where NOI = Annual Gross Income − Annual Operating Expenses (excluding debt service).

A property generating $28,000 NOI priced at $400,000 has a cap rate of 7.0%. That means if you paid all cash, you would earn a 7% annual return on your investment before financing costs.

Why Cap Rate Excludes Debt

Cap rate is a property-level metric, not an investor-level metric. Two investors buying the same property — one with cash, one with an 80% mortgage — face very different cash-on-cash returns, but the property's cap rate is identical for both. This makes cap rate useful for comparing properties regardless of how they are (or could be) financed.

Using Cap Rate to Estimate Value

Cap rate works in reverse to estimate what a property is worth:

Property Value = NOI / Cap Rate

If comparable properties in a neighborhood sell at a 6% cap rate, and a building generates $36,000 NOI, its implied value is $36,000 / 0.06 = $600,000. This is exactly how appraisers value commercial property — they determine the market cap rate from comparables, then apply it to the subject property's NOI.

Use the Cap Rate Calculator to run this calculation in both directions.

What Is a Good Cap Rate?

Cap rate benchmarks depend heavily on property type and location:

  • Prime urban markets (NYC, SF, London): 3–5% cap rates are standard. Low yield reflects high expected appreciation and low vacancy risk.
  • Secondary markets and suburbs: 5–7% is common. Better yield, more moderate growth expectations.
  • Regional and rural markets: 8–12%+ is possible. Higher yield often reflects higher management demands, vacancy risk, or capital expenditure requirements.
  • Commercial vs residential: Retail and office typically trade at higher cap rates than multifamily, reflecting higher vacancy risk and shorter lease terms.

Cap Rate and Interest Rates

Cap rates and interest rates are linked. When mortgage rates rise, investors require higher returns to justify buying — which pushes cap rates up and property prices down. When rates fall, buyers accept lower yields, pushing cap rates down and prices up.

The spread between the cap rate and the prevailing mortgage rate is the key lever. Buying at a 6% cap rate with a 7% mortgage means negative leverage — the property loses money relative to financing costs. At a 5% mortgage, the same 6% cap rate creates positive leverage.

What Cap Rate Does Not Tell You

Cap rate is a snapshot of current income. It does not capture appreciation potential, lease expiry risk, deferred maintenance, vacancy trajectory, or the cost of future capital expenditure. Always combine cap rate analysis with a physical inspection, rent roll review, and local market research before committing to a purchase.