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Cap rates: how real estate is priced
· Concept
Fact, law or dataA rule, statute, definition or measured number.
A capitalization rate is a property's net operating income divided by its price: real estate's version of an earnings yield.
See it on the Money & Finance map →How it works
A building with $500,000 of NOI selling for $10 million trades at a 5% cap; inverted, that is 20 times NOI. Cap rates reflect interest rates, expected rent growth and risk, so a stabilized apartment complex in a strong market trades at a lower cap than an aging suburban office. Small moves matter: the same $500,000 at a 6% cap is worth about $8.3 million, 17% less. The spread over the 10-year Treasury yield gauges the extra return demanded for property risk.
Why it matters
It ties value directly to income and rates, which is why rising rates after 2022 cut commercial property values even where rents held up.
Facts, rules and data
Appraisal practice (the income approach) and transaction data from CBRE cap-rate surveys, MSCI Real Capital Analytics, Green Street and NCREIF.
Debates and risks
In 2023 many deals priced at caps below borrowing costs ('negative leverage'); how far cap rates must rise to restore normal spreads is argued.
Connections (7)
▸The 10-year Treasury yield anchors Cap rates: how real estate is pricedMainstream view
The connection
The 10-year Treasury is the safe alternative to owning property, and commercial loans are priced off similar Treasury yields. Buyers want a cap rate equal to that yield plus a risk premium, minus expected NOI growth. When the 10-year rose from about 1.5% in 2021 to near 5% in October 2023, cap rates rose and values fell.
When and why
Most visible in US commercial real estate during 2022–24, and earlier in the high-rate 1980s; office properties were hit hardest.
How solid is the link?
Research from CBRE, Green Street and others shows cap rates following Treasury yields over time, with lags and wide variation in the spread.
Debates and risks
The spread over the 10-year has swung from below zero in the high-inflation early 1980s to about 5 percentage points; how much rent growth can offset rate moves is argued.
▸Earnings, market cap and the P/E ratio is the stock-market cousin of Cap rates: how real estate is pricedMainstream view
The connection
Both measure what a buyer pays for a dollar of income. A cap rate is NOI divided by price; a stock's earnings yield is earnings divided by price, the inverse of the P/E. A 5% cap is like a P/E of 20. Both fall when interest rates drop or growth looks brighter.
When and why
The P/E has been a staple since Graham and Dodd's Security Analysis (1934); cap rates are the core of the appraiser's income approach.
How solid is the link?
An arithmetic identity taught in finance and appraisal texts; analysts routinely compare both yields with the 10-year Treasury.
Debates and risks
How to compare them is debated: NOI excludes interest, taxes and depreciation, so a cap rate is closer to a company's EBITDA yield than to its earnings yield.
▸Cap rates: how real estate is priced are how investors price Real estate as an investmentFact, law or data
The connection
Under the income approach, value equals NOI divided by the market cap rate. Appraisers, lenders and buyers pick the rate from comparable sales, then cross-check with discounted cash-flow models. Because lenders size loans on appraised value and debt coverage, a cap rate shift moves both price and borrowing capacity.
When and why
Standard in US appraisal practice for decades; set out in the Appraisal Institute's textbook The Appraisal of Real Estate.
How we know
Appraisal standards (USPAP) and transaction databases such as MSCI Real Capital Analytics and CoStar record cap rates on actual sales.
Debates and risks
Reported cap rates depend on how NOI is defined, in-place or projected, with or without reserves, so cross-deal comparisons are imprecise.
▸Ground leases and leasehold financing trade at low Cap rates: how real estate is pricedMainstream view
The connection
Ground rent is very safe: it is paid before the building's mortgage, and if the tenant fails, the landowner gets the building. Investors therefore accept low yields, often about 3–5%, well below the cap rate on the office building above. Safe income means a low cap rate and a high price per dollar of rent.
When and why
In US markets where ground leases are common; Safehold's public filings report its ground-lease yields.
How solid is the link?
Safehold filings, appraisal practice and market surveys of ground-lease pricing; the logic is standard cap-rate math.
Debates and risks
Critics say cheap ground leases shift value from building owners to landowners over time; supporters say they lower total capital cost.
▸Underwriting a property loan: DSCR, LTV and debt yield values the collateral using Cap rates: how real estate is pricedFact, law or data
The connection
Appraisers value income property by dividing NOI by a market cap rate. A rise from 6% to 7% cuts a $1 million NOI building's value from about $16.7 million to $14.3 million, and a 65% LTV loan from about $10.8 million to $9.3 million, with no change in rent.
When and why
Every appraisal for a US bank or CMBS loan; appraisers follow the USPAP standards.
How we know
Appraisal reports, federal FIRREA appraisal rules, and cap rate surveys from CBRE, Green Street and others.
Debates and risks
Office cap rates are uncertain when few buildings trade, so appraisals can lag reality in either direction.
▸Loan-to-value (LTV) ratio jumps when values fall from rising Cap rates: how real estate is pricedFact, law or data
The connection
Income property is valued as NOI divided by the cap rate. With $800,000 of NOI, a building is worth $10 million at an 8% cap rate but $8 million at 10%. The loan does not shrink, so a $6.5 million loan goes from 65% to about 81% LTV, which can block a refinance.
When and why
Across US commercial real estate as interest rates rose in 2022–23; office cap rates widened the most.
How we know
Appraisals, broker cap-rate surveys and price indexes such as Green Street's show values falling as rates rose; refinance shortfalls appear in servicer reports.
Debates and risks
Few office buildings trade, so true cap rates, and therefore current LTVs, are estimates that appraisals update slowly.
▸Commercial real estate markets: office, industrial, retail, apartments are priced through Cap rates: how real estate is pricedFact, law or data
The connection
Value equals NOI divided by the cap rate. A building with $1 million of NOI is worth about $14.3 million at a 7% cap, but $12.5 million at 8%, about 12.5% less. Cap rates follow the 10-year Treasury plus a risk spread, so rising rates after 2022 cut values even where rents held.
When and why
In appraisals and sale pricing nationwide; tracked by CBRE's surveys and MSCI's transaction data.
How we know
Appraisal standards (the income approach) and published cap-rate and price indexes showing the post-2022 rise.
Debates and risks
Office cap rates are uncertain because few buildings trade, and many recent sales are distressed.