Cap rates are one of the most common ways real estate investors compare income-producing properties.
A cap rate, short for capitalization rate, measures the relationship between a property’s income and its value or purchase price. It can help investors compare apartment buildings, retail centers, office properties, industrial buildings and other income-producing real estate.
But cap rates are often misunderstood. A higher cap rate does not automatically mean a better deal. A lower cap rate does not automatically mean a safer property. Cap rates are a starting point, not a full investment analysis.
Key takeaways
- A cap rate compares net operating income with property value or purchase price.
- CBRE defines stabilized cap rates as stabilized NOI divided by acquisition price.
- The basic formula is: cap rate = NOI ÷ property value.
- Higher cap rates can signal higher income yield or higher risk.
- Lower cap rates can signal lower risk, stronger growth expectations or higher pricing.
- Cap rates do not include debt, taxes, depreciation, capital expenditures or future rent growth.
- Investors should compare cap rates by property type, market, lease quality and risk profile.
What is a cap rate?
CBRE’s U.S. Cap Rate Survey defines stabilized cap rates as the ratio of stabilized net operating income to the acquisition price of the asset. It defines value-add cap rates as stabilized NOI after property improvements divided by acquisition price plus value-add capital.
In simpler terms:
Cap rate = net operating income ÷ property value
Example:
- Property value: $1,000,000
- Annual net operating income: $70,000
- Cap rate: 7%
The cap rate tells the investor the property’s unlevered income yield before financing.
What is NOI?
Net operating income, or NOI, is income from the property after operating expenses but before debt service, income taxes, depreciation and capital expenditures.
A simplified NOI calculation is:
Rental and other property income – operating expenses = NOI
Operating expenses may include property management, repairs, insurance, property taxes, utilities paid by the owner and routine operating costs. Mortgage payments are not part of NOI.
That is why cap rates compare properties before financing choices. Two investors may finance the same building differently, but the cap rate starts with the property’s income and value.
Why investors use cap rates
Cap rates help investors compare deals quickly.
For example, if two similar apartment buildings are in the same market and one trades at a 5% cap rate while the other trades at a 7% cap rate, the investor should ask why. The 7% cap may offer more income relative to price, but it may also have weaker tenants, higher expenses, deferred maintenance or less rent growth.
JLL’s early investor guide says cap rate tells investors how a property’s net income compares with price, while other metrics such as cash-on-cash return and weighted average lease term help show what a property is worth before committing.
Why higher is not always better
A high cap rate may indicate a higher income yield, but it can also indicate higher risk.
High-cap-rate properties may have weaker locations, short leases, tenants with lower credit quality, deferred maintenance, high vacancy, uncertain rent growth, market decline or more expensive financing.
A lower cap rate may reflect a stronger location, better tenants, longer leases, stronger rent growth or more investor demand.
Cap rate must be interpreted with context.
Cap rates and property value
Cap rates can also be used to estimate value.
If a property has $500,000 of NOI and the market cap rate is 6%, the estimated value is:
$500,000 ÷ 0.06 = $8.33 million
If the market cap rate rises to 7%, the same NOI supports a lower value:
$500,000 ÷ 0.07 = $7.14 million
That is why cap-rate movement matters. When cap rates rise, values can fall unless NOI grows enough to offset the increase. When cap rates compress, values can rise.
2026 cap-rate context
CBRE’s 2026 U.S. capital markets outlook said commercial real estate investment activity is expected to continue recovering and that cap rates for most property types are expected to decrease by 5 to 15 basis points. CBRE also said total returns will largely be driven by income and that asset selection and management will be key drivers of returns.
That means investors should not simply buy because cap rates are expected to compress. Income quality, tenant demand, lease rollover, expenses and capital needs still matter.
What cap rates miss
Cap rates do not show the full picture.
They do not account for loan terms, debt service, tax impact, capital expenditures, future rent growth, tenant rollover, leasing costs, reserves, renovation risk or exit value.
A property with a high cap rate but major future repairs may be worse than a lower-cap-rate property with stable tenants and minimal capital needs.
What this means
Cap rates are useful because they simplify income-property comparison. But investors should not reduce an entire deal to one percentage.
A smart investor uses cap rate alongside cash-on-cash return, debt service coverage, lease analysis, market rent growth, capital expenditure planning and exit assumptions.
The cap rate answers one question: “What income yield does this property produce at this price?” It does not answer whether the investment is actually right.
FAQ
What is a cap rate in real estate?
A cap rate is the ratio of net operating income to property value or acquisition price.
What is the cap rate formula?
The basic formula is: cap rate = net operating income ÷ property value.
Is a higher cap rate better?
Not always. A higher cap rate may mean higher income yield, but it may also signal higher risk.
What is NOI?
NOI is net operating income, or property income after operating expenses but before debt service, income taxes, depreciation and capital expenditures.
Do cap rates include mortgage payments?
No. Cap rates are based on NOI and value, not financing structure.
Sources with clickable URLs
- [CBRE — U.S. Cap Rate Survey H1 2025](https://www.cbre.com/insights/reports/us-cap-rate-survey-h1-2025)
- [CBRE — U.S. Real Estate Market Outlook 2026: Capital Markets](https://www.cbre.com/insights/books/us-real-estate-market-outlook-2026/capital-markets)
- [JLL — Early Investor’s Guide to Commercial Real Estate](https://www.jll.com/en-us/guides/the-early-investors-guide-to-breaking-into-commercial-real-estate)
- [Federal Reserve Bank of San Francisco — Commercial Real Estate and Low Interest Rates](https://www.frbsf.org/research-and-insights/publications/economic-letter/2013/04/commercial-real-estate-low-interest-rates/)
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