CRE glossary
Capitalization rate (cap rate)
A capitalization rate (cap rate) is the annual net operating income (NOI) of a property divided by its purchase price or current value, expressed as a percentage. Cap rates are the standard way investors quote yield on commercial real estate; lower cap rates mean higher prices (and lower yield), higher cap rates mean lower prices (and higher yield).
Cap rates are the inverse of price-to-earnings ratios used in equities. A property with $1M of NOI selling at a 5% cap rate is priced at $20M ($1M ÷ 0.05). The same property at a 7% cap rate is priced at $14.3M. A 200-basis-point cap-rate move can swing valuation by 30%+.
Cap rates compress in low-interest-rate environments (more capital chasing yield, prices rise) and expand when rates rise (capital demands more yield, prices fall). 2020–2022 saw cap rates compress to historic lows; 2023–2024 saw the largest cap-rate expansion in 15 years as Treasury yields jumped.
Class A office in tier-1 markets typically trades at 5–6.5% cap rates. Industrial/logistics: 5–7%. Multi-family: 4–6%. Retail centers: 6–9%. Tertiary markets and older assets trade 100–300 bps higher than trophy. Cap-rate spreads to the 10-year Treasury are the standard relative-value metric brokers and acquisitions teams watch.
Cap rate
Cap rate = NOI ÷ Property value × 100%
Example
- Annual NOI
- $1,250,000
- Purchase price
- $20,000,000
- Cap rate
- 6.25%
- If price drops to $17M
- Cap rate becomes 7.35%
Broker perspective
Tenant-rep brokers should know cap rates because they predict landlord behavior. A landlord acquired at a 5% cap rate is highly price-sensitive on every lease, they need yield to justify the basis. A landlord who bought at an 8% cap rate has more room to discount. Ask the listing agent how long the landlord has owned the building; it tells you everything.
Frequently asked
People also ask
Is a higher cap rate better?
For the buyer, yes, higher yield. For the seller, no, lower price. Cap rates are an inverse measure of value.
Do cap rates use gross or net income?
Net. Cap rate uses NOI specifically, gross income minus operating expenses, before debt service and capital expenditures.
How do cap rates relate to interest rates?
Strongly. As 10-year Treasury yields rise, cap rates expand (prices fall). The spread is typically 200–300 bps for institutional-grade CRE.
What's a 'going-in' vs 'stabilized' cap rate?
Going-in is at acquisition (could be artificially low if vacancy is high). Stabilized is the projected cap rate once leasing reaches market levels. Sophisticated buyers underwrite both.
Related terms
Net operating income (NOI)
Gross income minus operating expenses, before debt service, the income line cap rates and valuations depend on.
Operating expenses (OpEx)
All costs to run the building, taxes, insurance, utilities, janitorial, management, that get passed through to tenants in NNN and modified gross structures.
Base rent
The headline rent before pass-through expenses, usually quoted in $/SF/year and the starting point for every comp.
Ground lease
Long-term lease (50–99 years) of just the land, tenant builds and owns the building on top.
See capitalization rate (cap rate) extracted from a real lease.
Drop a 60-page lease, get a 38-field abstract in 90 seconds, every value cited back to the source page.