Capitalisation rate (cap rate)

The capitalisation rate — cap rate — is a property's net operating income expressed as a percentage of its price or current market value. It is the primary metric used to value commercial property.

The calculation

Cap rate = net operating income ÷ property value × 100

Rearranged, it is also how commercial property is valued:

Value = net operating income ÷ cap rate

A property with $150,000 net operating income valued at a 6% cap rate is worth $2.5 million.

Why it matters

In commercial property, value is driven by income and cap rate, not by comparable sales in the way residential is. Increase the net income, and the value rises by a multiple of that increase. That is the core of commercial value-add investing.

Adding $20,000 of net income at a 6% cap rate adds roughly $333,000 of value.

What drives the cap rate

Tenant quality, remaining lease term, lease structure, location, building quality, and prevailing interest rates. Lower cap rates mean higher prices — a "compressing" cap rate environment is a rising market.

Common misunderstanding

Cap rate is not the same as yield, though the terms are often used loosely. Cap rate is specifically based on net operating income and is a valuation tool. Residential gross yield uses gross rent and is a screening tool.

A high cap rate signals risk, not a bargain. Short lease term, weak tenant, secondary location. Ask why it is high before assuming it is good value.

Cap rates move with interest rates. A property bought at a low cap rate in a low-rate environment can lose value if rates rise even when its income is unchanged.

Related terms

Last reviewed: 1 August 2026 · ---

← Back to the Glossary