The Question Everyone Asks Wrong
"What's a good cap rate?" is the most common question in CRE investing. The answer is always "it depends," but most people stop there. They never explain what it depends on.
A 5% cap rate on a Class A multifamily in Miami is a different animal from a 5% cap rate on a suburban office building in Cleveland. Same number. Completely different risk profiles. If you treat them equally, you will eventually lose money.
Cap rate is simply NOI divided by purchase price. It tells you the unlevered yield on the property if you paid all cash.
But cap rate also has a deeper mathematical identity. The Gordon Growth Model decomposes it: Cap Rate = r - g, where r is the investor's required total return and g is expected long-run NOI growth. A 5% cap rate on a property where investors require 8% returns implies the market expects 3% annual NOI growth. When you buy at a 5% cap, you're not just accepting a 5% current yield. You're making a bet that growth will deliver the other 3%.
This decomposition explains why cap rates compress in hot markets (growth expectations rise) and expand in downturns (growth expectations fall). It also reveals the asymmetric downside risk of low-cap-rate deals: a $1M NOI property at a 5% cap is worth $20M. If required returns rise 200 basis points (to 10% total return) with growth unchanged, the cap rate becomes 7% and the property is worth $14.3M. That's a 28.5% value decline from a 200 basis point rate move.
Understanding this math is the difference between seeing cap rate as a number and understanding it as a signal.
The Mental Model: What Growth Rate Are You Buying?
Here is how to use this in practice. When you see a cap rate, invert the Gordon Model to extract the growth bet.
Take a 150-unit multifamily deal listed at a 5.5% cap rate. Institutional investors in this market typically require an 8.5% total return (based on comparable transaction IRRs). The implied growth rate is: g = r - cap rate = 8.5% - 5.5% = 3.0%.
Now ask: is 3% annual NOI growth realistic for this property? NCREIF data says institutional properties average about 200 basis points below inflation. If inflation is 3%, the empirical default is 1% real NOI growth. The deal is priced for 3% growth but history says expect closer to 1%.
That 200 basis point gap between the priced-in growth and historical reality is the risk you are taking. Maybe the deal is in a supply-constrained market with documented rent growth above 3%. Then the cap rate is fair. Maybe it is a 20-year-old property in a market with new construction delivering. Then you are overpaying.
The framework: Cap Rate = Required Return - Growth Bet. Every time you see a low cap rate, you are implicitly making a large growth bet. Make sure you can defend it.
Factor 1: Property Type
Different asset classes carry different risk premiums, and those premiums show up directly in cap rates.
| Property Type | Typical Cap Rate Range (2026) | Why |
|---|---|---|
| Multifamily | 4.5% - 6.5% | Lowest risk. Housing demand is structural. Shorter lease terms mean faster rent growth capture. |
| Industrial | 5.0% - 7.0% | Strong demand from e-commerce and nearshoring. Long lease terms reduce turnover risk. |
| Retail | 6.0% - 8.5% | Higher risk. E-commerce headwinds for some formats. Experiential retail holding up better. |
| Office | 7.0% - 10.0%+ | Highest uncertainty. Remote work has permanently reduced demand in most markets. |
These ranges come from the CBRE Cap Rate Survey (H2 2025), which tracks 3,600+ estimates across 50 markets.
The core insight: a lower cap rate means the market is pricing in lower risk. You are paying more per dollar of NOI because the income stream is considered more stable. A higher cap rate means the market sees more risk and demands more return to compensate.
Factor 2: Market Tier
Not all geography is equal. Institutional investors categorize markets into tiers based on size, liquidity, and economic diversity.
Primary markets (New York, LA, Chicago, Dallas, Miami): Cap rates compress because capital competes aggressively for limited inventory. More buyers means higher prices relative to income.
Secondary markets (Nashville, Charlotte, Austin, Denver): Slightly higher cap rates. Strong fundamentals but less liquidity. A deal takes longer to exit.
Tertiary markets (smaller MSAs, college towns, single-industry cities): Highest cap rates. Fewer buyers, more exit risk, thinner rent comps. The yield looks attractive until you need to sell.
The same property type can have a 200+ basis point spread between a primary and tertiary market. That spread is the market pricing in liquidity risk.
Factor 3: Risk-Free Rate Environment
Cap rates don't exist in a vacuum. They sit on top of the risk-free rate (typically the 10-year Treasury yield) plus a risk premium. This is the spread to Treasury.
The CFA Institute documented that the historical average spread between CRE cap rates and the 10-year Treasury has been approximately 200 basis points since 1990. When that spread compresses below 150 basis points, CRE is offering less compensation for risk than usual.
In practice, this means:
- If the 10-year Treasury yields 4.3%, a cap rate below 5.8% means you are being paid less than the historical average for taking CRE risk.
- That doesn't automatically make it a bad deal. But it means the deal needs strong rent growth or a value-add component to justify the compressed spread.
- If the spread is below 100 basis points, you should seriously question whether the risk-adjusted return justifies tying up capital in an illiquid asset.
The Quick Screen tool on this site calculates this spread automatically and flags it yellow or red when it falls below historical norms.
Factor 4: Value-Add vs. Stabilized
A stabilized property (fully leased, market rents, no deferred maintenance) should trade at a tighter cap rate because the income stream is proven. You are buying certainty.
A value-add property (below-market rents, needed renovations, lease-up risk) should trade at a wider cap rate because you are buying uncertainty. The current NOI doesn't reflect the property's potential.
The mistake retail investors make: comparing the going-in cap rate on a value-add deal to the cap rate on a stabilized deal and concluding the value-add is "cheaper." The value-add deal has a higher cap rate because it carries execution risk. You are being compensated for the chance that your renovation plan, rent increase assumptions, or lease-up timeline doesn't work.
The institutional approach: underwrite value-add deals to the stabilized cap rate. Start with where you expect the property to be after your business plan is complete. Work backward to determine whether the going-in price makes sense given the capital needed to get there.
The Bias Check for Cap Rates
Before you assess any cap rate, run through these questions:
Am I comparing within the same property type and market tier? A 6% cap on multifamily is tight. A 6% cap on suburban office might be aggressive given current demand trends.
What's the spread to the 10-year Treasury? If it's below 150 basis points, you need a clear thesis for why this specific deal justifies a compressed risk premium.
Is this a stabilized or value-add play? If value-add, am I being compensated for execution risk? What happens to my returns if rent increases come in 20% below projections?
What cap rate am I assuming at exit? If you are buying at a 5.5% cap and projecting a sale at a 5% cap in five years, you are betting on further cap rate compression. That's a directional bet, not an underwriting assumption.
One More Thing: Cap Rate Overstates True Yield
A subtlety most content skips: cap rate uses NOI in the numerator, and NOI does not deduct capital expenditures (roof replacements, HVAC, parking lot resurfacing). NCREIF data shows CapEx averaging 1-2% of property value annually, or roughly 100-200 basis points below the cap rate.
A 6% cap rate property with typical CapEx generates a true cash yield closer to 4-5%. The institutional metric that captures this is PBTCF (property before-tax cash flow), which subtracts CapEx from NOI. If you're comparing your deal's cap rate to a Treasury yield, remember: the Treasury pays its coupon without sending you a bill for a new roof.
Where to Go Next
Cap rate is the first number you look at. It is not the last. Once you have assessed the cap rate, the next questions are:
- Is leverage helping or hurting? Read Positive vs Negative Leverage to understand whether your financing terms amplify or destroy returns at this cap rate.
- Can the property service its debt? Read DSCR Explained for the lender's perspective on your deal.
- Is the broker's NOI real? Read How to Read a Pro Forma to audit the NOI that produces the cap rate.
Sources
- CBRE U.S. Cap Rate Survey, H2 2025
- CFA Institute, "The Interplay Between Cap Rates and Interest Rates" (2024)
- Geltner et al., "Commercial Real Estate Analysis and Investments," 2nd Edition (2007), Chapters 8-9: PV Mathematics and Returns
- NCREIF Property Index: CapEx data (1978-2004 empirical average)