What Cap Rate Actually Measures
Cap rate is net operating income divided by property value, expressed as a percentage. A $300,000 property generating $24,000 NOI per year has an 8% cap rate. It measures the unleveraged return — what the property yields before any mortgage payments.
NOI is revenue minus operating expenses (insurance, taxes, maintenance, management fees, vacancy allowance). It does not subtract mortgage principal or interest. Two investors buying the same property with different financing will have identical cap rates but very different cash-on-cash returns.
Cap rates vary significantly by market and property type. Class A multifamily in major metros has traded at 4–5%; industrial assets in secondary markets can exceed 8%. Higher cap rates reflect either stronger income relative to price, higher perceived risk, or slower expected appreciation — often all three.
Frequently Asked Questions
Is a higher cap rate better?
It depends on your goal. A higher cap rate means more income relative to price, which is better for cash flow. But high cap rates in strong markets often reflect older buildings, deferred maintenance, or locations with slower rent growth. A 4.5% cap rate on a well-located multifamily in a growing city can outperform a 9% cap rate on a struggling retail property over a 10-year hold.
How does cap rate relate to property value?
If you know the market cap rate and the property's NOI, you can estimate value: Value = NOI ÷ Cap Rate. A property with $30,000 NOI in a 6% cap rate market is worth roughly $500,000. This is how commercial appraisers use cap rates — you're essentially applying a market multiple to income.
What's a good cap rate to target?
There's no universal answer. A rule of thumb: cap rate should exceed the risk-free rate (10-year Treasury) by at least 200–300 basis points to justify illiquidity and management risk. In a 4.5% Treasury environment, a sub-5% cap rate offers thin compensation for real estate risk. Most buy-and-hold investors target 6–8% in secondary markets.