Cap rates, or capitalization rates, are one of the most essential metrics in commercial real estate (CRE). Whether you are an investor, lender, or broker, understanding cap rates is crucial for evaluating opportunities and navigating the ever-evolving market landscape. This guide breaks down the fundamentals of cap rates, their significance, and their role in decision-making.
What Is a Cap Rate?
At its core, a cap rate is a simple formula:
Cap Rate = Net Operating Income (NOI) / Property Value
This calculation provides a snapshot of the return on investment for an income-producing property. For example, a property generating $100,000 in NOI and valued at $1,000,000 would have a cap rate of 10%. Calculating the cap rate is a simple and powerful tool for assessing value, comparing properties, and estimating risk.
When a property has a low cap rate, it is typically seen as a lower-risk investment, often in a premium location or with high-quality tenants.
A property that carries a higher cap rate suggests greater risk or potentially higher returns, often associated with secondary markets, distressed properties, or shorter lease terms.
For properties where sales prices and income are dropping, cap rates increase. This is because the denominator in the cap rate ratio gets smaller and the numerator stays the same (or decreases). If the rental income (and thus the NOI) of the property rate declines, likely due to increased vacancy rates and lower rent prices, cap rate expansion can occur.
A number of office properties, which have suffered from increased vacancy rates and fewer leases since the pandemic, have seen cap rates increase significantly.
One recent example illustrates the ongoing recalibration of office building values in today’s environment. The historic 470 Park Avenue South office building in New York City sold in January 2025 (just a few days ago!) at a 40% discount for $147.5 million—nearly $100M lower than its 2018 sale price of $245 million. Addressing the steep price drop, Michael T. Cohen, a principal at Williams, explained to the New York Post, “We’re now in a post-pandemic interest rate and cap rate environment, very different from what existed in 2019 and for 10 or 20 years prior. The result has been sizable adjustments in values that are not in any way reflective of the values of a building.”
Factors Influencing Cap Rates
Cap rates do not exist in a vacuum; they are shaped by a variety of market and property-specific factors. Market conditions such as inflation, interest rates, and the yield on the 10-year Treasury significantly impact cap rates, as they shape the cost of capital and investors’ required returns.
At the same time, property-specific attributes play a crucial role. Factors like location, asset class, and the property’s vacancy rate directly affect its perceived risk and income potential. In the office sector, for example, the class of the property (A, B, or C) further distinguishes its desirability and potential return.
What is Considered a “Good” Cap Rate?
Determining what constitutes a “good” cap rate depends largely on the investor’s risk profile and objectives. CRE investors vary in their risk tolerances based on factors such as investment strategy, financial goals, current market conditions, and the specific asset class.
Investors with a more conservative approach may favor lower cap rates, as these are typically associated with stable, lower-risk assets, such as properties in prime locations with long-term, creditworthy tenants. Conversely, investors seeking higher returns are often willing to accept the higher risk associated with higher cap rates, which are commonly found in secondary or tertiary markets, or in assets with shorter lease terms or less stable income streams.
Ultimately, a “good” cap rate is one that aligns with an investor’s unique balance of risk and reward, as well as their broader investment strategy.
Cap Rates Trends in 2024
In 2024, cap rates across CRE in the U.S. reflected a mix of compression and expansion, driven by economic conditions, property-specific factors, and investor sentiment.
Office Properties:
- Trend: Cap rates increased significantly.
- Details: Stabilized cap rates rose by approximately 40 basis points, with Class A cap rates exceeding 8%. Class C properties saw cap rates rise into the low teens due to weaker demand.
Industrial Properties:
- Trend: Cap rates decreased during the first half of 2024.
- Details: Strong investor confidence in logistics and warehousing assets contributed to lower cap rates, particularly in high-demand markets.
Multifamily Properties:
- Trend: Cap rates remained stable.
- Details: Average cap rates were ~5.3%, reflecting steady investor interest in residential rental markets, especially in growing Sunbelt cities.
Retail Properties:
- Trend: Mixed movements across the sector.
- Details: Average cap rates were ~6.4%, with variations based on tenant quality, location, and consumer spending patterns.
Source: CBRE
These trends highlight the importance of a nuanced, sector-specific approach for investors assessing opportunities in the commercial real estate market.
Cap Rates Across Asset Classes
Cap rates, which reflect the return on investment for real estate properties, vary significantly across different asset classes and market tiers, influenced by factors such as property type, location, and prevailing market conditions.
Multifamily Properties: These assets typically exhibit lower cap rates, indicating strong demand and stable cash flows. Analysts project an average annual rent growth of 2.6% in 2025, with certain markets exceeding 3%. This growth is driven by strong renter demand and a shrinking construction pipeline, which together decrease vacancy rates and support rent growth, further enhancing property income and valuations, compressing cap rates.
Retail Properties: Retail assets often present higher cap rates, especially in secondary markets or for properties with shorter lease terms, due to perceived higher risks associated with tenant turnover and market volatility. CBRE’s H1 2024 Cap Rate Survey reported an average cap rate of 6.4% for retail assets, indicating investor caution due to factors like tenant turnover and market volatility. Additionally, single-tenant net-leased dollar stores had an average cap rate of 7.22% in Q2 2024, further illustrating the higher yields demanded by investors for retail properties with perceived higher risks
Industrial Properties: Industrial assets tend to exhibit lower cap rates in high-demand markets, fueled by the sector’s sustained investor interest driven by the e-commerce boom and supply chain needs. Despite the national warehouse vacancy rate rising to 6.7% in Q4 2024—more than double the 3% rate recorded at the end of 2022, according to Cushman & Wakefield data—industrial rents are climbing. Typically, higher vacancy rates would result in falling rents, but the boon of data center demand and the anticipated lower construction starts in the sector have defied this trend. Average asking rent grew to $10.13 per square foot in Q4 2024, up 4.5% from a year earlier and 61% from 2019. Mark Russo, head of industrial research at real estate firm Savills, noted that tenants renewing leases signed in 2020 or 2021 face steep rent hikes. “Rents in some cases are ‘up maybe two or three times than they were five years ago,'” he explained, highlighting the dramatic rise in costs for industrial space over the past few years.
Office Properties: As the office sector continues to face challenges, investors are seeking opportunities to improve a property’s competitiveness through redevelopment. Just one example to highlight: in December 2024, BXP acquired a 302,000-square-foot office property at 725 12th Street NW in Washington, D.C., for $34 million, amounting to roughly one-third of the property’s assessed value and just over half of the $61 million that Hines paid for the development three decades ago. The building, previously valued higher, had been vacant for about two years, allowing BXP to purchase it at a significant discount. BXP plans to demolish and redevelop the property into a premier workplace. Successful redevelopment can decrease the perceived risk associated with a property, as it may address issues like outdated design or poor condition, leading to a lower cap rate due to increased investor confidence.
Cap Rates Are an Important Metric, But Not the Only One
Cap rates are a cornerstone of decision-making in CRE. Investors use them to assess potential deals, lenders rely on them to gauge risk, and brokers utilize them to set pricing expectations. Additionally, cap rates serve as a benchmark for tracking market trends and identifying shifts in investor sentiment.
However, while cap rates are a crucial tool in assessing the value of a property, they have limitations. Cap rates are a snapshot in time and do not account for factors like income growth, future expenses, or market volatility. For a well-rounded analysis, investors should pair cap rates with other tools like discounted cash flow (DCF) analysis, debt coverage ratios, and market trend studies.
For more insights on navigating cap rates, tune into The CRE Weekly Digest podcast. Episodes explore factors influencing cap rates, major transactions, economic news, and industry trends to keep you informed.
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