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Cap Rates Explained

Cap rate equals net operating income divided by property value, the core formula behind how commercial real estate gets priced

The Basic Formula

A capitalization rate, or cap rate, is the most widely used shorthand for pricing commercial real estate. It relates a property's income to its value:

Cap rate = Net Operating Income / Property Value (or purchase price)

Illustration: a shopping center generates $10 million of annual NOI and trades for $200 million. Its cap rate is $10M / $200M = 5%. Flip the formula around and it also works as a valuation tool: at a 5% cap rate, that same $10 million of NOI implies a value of $10M / 5% = $200 million.

Cap Rates Move Inversely to Price

For a given level of NOI, a lower cap rate corresponds to a higher price, and vice versa. If buyers are only willing to accept a 4% return on that same $10 million of NOI, the implied price rises to $10M / 4% = $250 million. If they demand a 6% return, the implied price falls to about $167 million. This inverse relationship is conceptually similar to the relationship between a bond's price and its yield, a lower cap rate means the market is paying more for each dollar of current income, generally because it expects that income to grow, views the asset as lower-risk, or both.

What Moves Cap Rates

Cap rates aren't fixed, they shift with market conditions, including:

• Interest rates - cap rates have historically tended to move with the broader cost of capital, though not always in lockstep or by the same amount (see interest rates and REITs); when borrowing costs and yields on safer assets rise, buyers generally need real estate to offer a higher income return too
• Property quality and location - newer, better-located, more in-demand assets typically trade at lower cap rates (higher prices per dollar of NOI) than older or secondary-market assets, as investors accept a lower current return in exchange for greater confidence in durability
• Sector demand - capital flowing heavily into (or out of) a particular property type, like industrial or data centers, can compress or widen cap rates for that sector specifically, even for individual assets whose own operating performance hasn't changed

Going-In, Stabilized, and Exit Cap Rates

Real estate investors distinguish between a few variations on the same idea: the going-in cap rate (based on current, in-place NOI at the time of purchase), the stabilized cap rate (based on projected NOI once a property reaches full, normal occupancy, relevant for a property being leased up or renovated), and the exit cap rate (the cap rate assumed at eventual sale, used in underwriting models). A property bought at a high going-in cap rate because it's under-leased can still be an attractive investment if its stabilized cap rate, once occupancy and rents normalize, is meaningfully lower.

Cap Rates and REITs

Cap rates are a private real estate transaction concept, not a line item in a REIT's financial statements. They matter to REIT investors in two main ways: they're the mechanism analysts use to build a Net Asset Value estimate for a publicly traded REIT's portfolio, and they set the going-in economics whenever a REIT buys or sells a property. The public-market equivalent, inferring a cap rate from a REIT's stock price rather than a private transaction, is called the implied cap rate, covered in the next guide.

Where the Inputs Come From

Actual cap rates on private transactions aren't published in a centralized, free database, they come from broker reports, appraisals, and transaction comps tracked by commercial real estate research firms. What you can find in public REIT filings is the NOI side of the equation, including same-store NOI, and, when a REIT discloses the terms of a specific acquisition or disposition, the cap rate on that individual deal. See how to read a REIT earnings supplement for where that shows up.

Cap Rate vs. Discount Rate

A cap rate is a single-year snapshot - it relates one year of NOI to a price, with future growth and risk baked implicitly into the rate itself rather than modeled explicitly. A discount rate, used in a full discounted cash flow (DCF) analysis, instead projects NOI (and eventual sale proceeds) over many future years and discounts each year's cash flow back to a present value. The two approaches can be reconciled mathematically under certain simplifying assumptions about constant growth, but in practice they serve different purposes: cap rates are useful for quick, standardized comparisons across many properties, while a full DCF is better suited to modeling a single asset's unique growth trajectory in detail.

The gap between a going-in and a stabilized cap rate is often the whole investment thesis behind a value-add acquisition - a buyer effectively wagers that leasing up vacant space, renovating units, or resolving below-market legacy leases will lift NOI enough to make the stabilized return look attractive, even if the current, in-place return looks unremarkable at the time of purchase. Cap rates are typically quoted for a specific property, but market participants also talk about "market cap rates" for a given property type and metro area at a given point in time, based on recent comparable transactions.

See it in the data: Browse the REIT directory → Compare REIT sectors →

Research and education only — nothing here is investment advice. Figures such as the 90% distribution rule are general and can change; always confirm against a company's filings.