Cap Rate Calculator: How to Value Commercial Real Estate Properties

The formula

Cap rate equals net operating income divided by property value. Net operating income is gross income minus operating expenses, before debt service, capital expenditures, depreciation and income taxes. A property with $500,000 of NOI that sells for $7,142,857 traded at a 7.0% cap rate.

In practice the formula runs the other way: value equals NOI divided by cap rate. If comparable properties trade at 7.0% and yours produces $500,000, the implied value is $7,142,857. At 6.5% it is $7,692,308. A 50 basis point change in the rate moved the value by $550,000. That sensitivity is why cap rate assumptions carry so much weight in any valuation.

What moves cap rates

Risk and tenant credit. A cap rate is a risk-adjusted yield. A single-tenant building on a 15-year net lease to an investment-grade tenant carries far less risk than a strip center of local tenants on three-year terms. Lower risk means buyers accept a lower yield, which means a lower cap rate and a higher price per dollar of NOI.

Interest rates. The correlation is loose but real. When borrowing costs rise, the spread between the cap rate and the mortgage rate narrows and returns on borrowed money fall, so buyers demand higher cap rates. A 100 basis point move in Treasuries does not produce a 100 basis point move in cap rates, but the pressure runs in that direction and it persists.

Supply and demand. Markets with strong tenant demand and little new construction see cap rates compress as buyers compete. Overbuilt or shrinking markets see them widen. Gateway markets trade tighter than secondary markets because the buyer pool is deeper.

Remaining lease term. A property with 12 years of term is worth more than the same property with three, at identical NOI, because the income is more certain. A drugstore with 15 years left might trade at 5.5%. The same building with four years left might trade at 7.5%.

Liquidity. Sectors with deep institutional buyer pools, such as industrial and multifamily, trade at lower cap rates than niche sectors where the buyer pool comes and goes.

Ranges by property type

These are approximate and shift with the cycle. They vary by market, quality, vintage and occupancy.

Single-tenant net lease, investment-grade credit: 5.0% to 6.5%. The tightest in the business, because the income looks like a bond.

Multi-tenant retail: 6.5% to 8.5%. Grocery-anchored trades at the low end, unanchored strips at the high end.

Class A office in gateway markets: 5.5% to 7.0%, with a wider range and more uncertainty since 2020.

Suburban office: 7.0% to 9.0%. More rollover risk, less institutional interest.

Industrial and logistics: 4.5% to 6.5%. Class A logistics in the major distribution markets can trade under 5%.

Multifamily: 4.5% to 6.0%. Short leases reprice quickly to inflation and the capital markets are deep.

Self-storage: 5.5% to 7.5%. Low operating cost, low capex, sticky tenants.

A Class A warehouse in the Inland Empire and a Class B industrial park in rural Ohio are both "industrial." They do not share a cap rate.

Going-in versus exit

The going-in cap rate is year one NOI over purchase price: the current yield on the acquisition. The exit cap rate is the assumed rate at sale, used in a DCF to calculate the reversion value.

Convention sets the exit cap 25 to 75 basis points above the going-in cap. The building will be older, the leases shorter, and conservative underwriting assumes the market will not be more favorable at sale than today. Investment committees and lenders question any model that skips the premium.

The exit cap has outsized effect on returns. In a ten-year hold the reversion is usually 60% to 70% of total value. A 25 basis point change in the exit cap can move projected IRR by 100 to 200 basis points. Stress-test it before anything else in the model.

When the cap rate misleads

Pro forma NOI. A broker package showing a 7.5% cap may be using NOI that assumes higher occupancy, market rents and lower expenses than the property achieves today. The in-place cap rate might be 5.5%. You are paying for income that does not exist yet. Underwrite the gap as execution risk.

Below-market and above-market rents. Below-market rents depress NOI and inflate the cap rate, so the property looks cheap, but the upside is already in the price if the seller is pricing on a mark-to-market. Above-market rents do the opposite and hide rollover risk. The cap rate cannot tell sustainable income from unsustainable income.

Capital needs. NOI excludes capital expenditures. A 7.0% cap on a building with $2 million of deferred maintenance is a different investment from a 7.0% cap on a renovated one. Look below the NOI line.

Financing. Cap rates are unlevered. A 6.0% cap with 4.0% debt adds to the equity return, and the same cap with 6.5% debt subtracts from it. Judge the cap rate against the debt you can actually get.

Cap rate versus DCF

A cap rate is a snapshot: current NOI over value. It works for stabilized assets with predictable income and it is the fastest way to compare opportunities and check pricing against the market.

A discounted cash flow models income and expenses year by year over the hold, then discounts them to present value. It is necessary for anything with complexity: rollover during the hold, a repositioning, a capital program, or unusual rent structures. For institutional underwriting the cap rate gets the deal in the door. The DCF is the decision tool.

Most people use both. Our free cap rate calculator covers the quick check. The valuation engine handles the full DCF with sensitivity tables, so the screening number and the investment committee number come from the same inputs.