What Is a Good Cap Rate?

What the cap rate actually measures

Cap rate is net operating income divided by value. It describes the unleveraged annual yield of the property, which is why it is used to compare assets without financing distorting the picture.

Because value equals NOI divided by cap rate, the metric is also a valuation tool: apply the cap rate that comparable buildings trade at to the NOI you can defend.

Why higher is not automatically better

Cap rates rise as perceived risk rises. Older buildings, weaker rental demand, single-employer towns and deferred maintenance all push cap rates up because buyers demand more current yield to compensate.

A property advertised at a very high cap rate usually deserves more scrutiny, not less. Check whether the NOI includes management, vacancy and reserves, and whether the rents are sustainable.

How to judge a cap rate in practice

Compare like with like: same submarket, similar unit mix, similar age and condition, and NOI calculated the same way. Recent sales are the only reliable benchmark.

Then check the spread against your mortgage rate. When your borrowing rate is near or above the cap rate, leverage stops helping cash flow and starts hurting it.

• Rebuild NOI yourself before computing the cap rate.
• Benchmark against verified recent comparable sales.
• Compare the cap rate to your all-in cost of debt.
• Ask what would need to be true for the cap rate to look cheap in five years.

Frequently asked