Last updated: November 5, 2026
In commercial real estate, the capitalization rate, or cap rate, is a property's net operating income divided by its value or purchase price. It expresses the unlevered annual return a property produces, before financing. Investors use it to compare deals, estimate value from income, and read how a market prices risk.
Cap rate = Net Operating Income / Property Value. If a building produces 500,000 in annual NOI and sells for 8,000,000, the cap rate is 6.25 percent. These are illustration numbers only.
The formula can be rearranged to estimate value: Value = NOI / Cap Rate. That is why brokers and appraisers often talk about a market cap rate for a given property type and location.
NOI is the property's income minus operating expenses. Income includes rent and other revenue such as parking or reimbursements. Expenses include taxes, insurance, utilities paid by the owner, repairs, management, and similar operating costs. NOI excludes mortgage payments, depreciation, and usually capital expenditures.
A higher cap rate means more income relative to price. It can signal higher perceived risk, a weaker location, older property, shorter leases, or simply a better buy. A lower cap rate means buyers are paying more for each dollar of income, often because the asset is seen as safer or has stronger growth potential.
A cap rate is a snapshot of one year of income. It does not capture rent growth, lease rollover, capital needs, or financing. Two buildings with the same cap rate can have very different futures. That is why investors pair it with cash flow projections, internal rate of return, and lease analysis.
Both start from NOI, but they answer different questions. Cap rate compares NOI with value and ignores the loan, so it tells you about the asset's pricing. DSCR compares NOI with debt payments, so it tells you whether the property can carry its financing. A property can have an attractive cap rate and still struggle with coverage if it is financed with too much debt.
Different asset classes tend to trade at different cap rate ranges because their risks differ. Apartments benefit from many small leases and steady housing demand. Industrial buildings have been favored by investors for logistics demand. Office and some retail face more questions about future demand. The ranges shift over time with markets and rates, so always check current surveys rather than relying on old rules of thumb.
The going-in cap rate uses the purchase price and current or first-year NOI. The exit, or terminal, cap rate is an assumption about the rate a future buyer will pay when you sell. Underwriting a higher exit cap rate than the going-in rate is a common conservative choice.
Is cap rate the same as ROI? No. ROI usually includes financing and appreciation. Cap rate is unlevered and based on one year of income.
Is cap rate used for houses? It can be, but it is most common for income properties.
Related: briefcase.email/guides/what-is-a-good-cap-rate-for-commercial-real-estate and briefcase.email/guides/what-is-dscr-in-real-estate.
Educational note: This page is general information, not investment, lending, tax, or legal advice. Briefcase is a media and marketing company, not a lender, broker, or advisor. Confirm terms and figures with qualified professionals before making decisions.
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