A cap rate, short for capitalization rate, is a commercial property's annual net operating income divided by its price or value. A retail centre that earns $312,000 a year and sells for $4,800,000 trades at a 6.5% cap rate.
US bank examiners use the same definition. The Office of the Comptroller of the Currency (OCC) calls the capitalization rate "the ratio between a property's stabilized NOI and the property's sales price to convert income into value" (OCC handbook).
Net operating income (NOI) is a year of rent and other income, less vacancy and operating expenses, before any loan payment. The loan stays out of the figure, so two buyers with different financing see the same cap rate. Our glossary shows how NOI and the other valuation terms fit together on one building.
The formula runs three ways:
| To find | Calculation | Retail centre |
|---|---|---|
| Cap rate | NOI divided by price | $312,000 / $4,800,000 = 6.5% |
| Value | NOI divided by cap rate | $312,000 / 0.065 = $4,800,000 |
| NOI a price implies | Price times cap rate | $4,800,000 x 0.065 = $312,000 |
Appraisers and lenders use the second row. Our valuation guide shows how cap rates and NOI turn income into value on a full appraisal.
Four US banking agencies describe the cap rate as "the number of cents per dollar of today's purchase price investors would require annually over the life of the property to achieve their required rate of return" (interagency policy statement). At 6.5%, the buyer accepts 6.5 cents of income a year for each dollar paid.
A low cap rate means buyers pay more for each dollar of a building's income, and a high cap rate means they pay less. The price is a multiple of income: at a 5% cap rate a building sells for 20 times its NOI, and at 8% for 12.5 times.
Buyers pay the higher multiple when they expect the income to last or to grow. Economists at the Federal Reserve Bank of San Francisco wrote that the ratio "is largely a function of interest rates and expected increases in the property's price" (San Francisco Fed). Four things move the rate on a given building:
- Lease term and tenant strength. A long lease to a strong tenant makes the income safer, so buyers accept a lower rate.
- Rent growth. The same economists note that "expected increases in rent or lower vacancies tend to lower the cap rate".
- Building age. A newer building has a longer useful life, which the agencies link to a lower cap rate.
- Interest rates. Higher bond yields raise the return buyers ask of property.
The better cap rate depends on your side of the sale. A seller wants a low rate, because the same income fetches a higher price. A buyer who wants income today prefers a high rate and accepts the risk that comes with it. A high cap rate is how the market prices weaker tenants, shorter leases or flat rents.
A cap rate measures the building, while ROI and cash-on-cash return measure one buyer's deal. Cash-on-cash return divides the cash left after loan payments by the cash invested, so the same building gives two buyers two different returns. Our investing guide tests whether leverage always increases returns.
A cap rate also covers a single year. The agencies call it "a static one-year analysis", and a discount rate, which prices many years of income, typically runs higher.
The Federal Reserve's measure of US commercial cap rates stood at 6.45% in February 2026, below its average of 6.87% since 2001 (Federal Reserve, data tables). The series is a 12-month moving average across industrial, retail, office and multifamily sales, so it trails the market and blends four property types. It reached its low of 5.50% in August 2022.
The Fed's own reading is that cap rates "have recovered from historical lows reached in 2022, rising to a level just below its historical average in the most recent data" (Federal Reserve, Financial Stability Report).
Source: Board of Governors of the Federal Reserve System, Financial Stability Report, May 2026 (capitalization rates at property purchase, 12-month moving average, data from MSCI Real Capital Analytics), and market yield on U.S. Treasury securities at 10-year constant maturity, monthly, via FRED (series GS10). January 2001 to February 2026.
The series is national. The rate for one property type or one city comes from the sales that appraisers and brokers collect in that market.
Cap rates rise and fall with interest rates, by smaller amounts. From December 2021 to February 2026, the 10-year Treasury yield rose from 1.47% to 4.13%, a gain of 2.66 points (FRED, 10-year Treasury yield). The Fed's cap rate measure rose from 5.69% in December 2021 to 6.45% in February 2026, a gain of 0.76 points. The gap between the two narrowed from 4.22 points to 2.32.
The moving average explains part of the lag. Expected rent growth explains more: buyers who expect rising rents accept a thinner margin over bonds. A small move still matters: our market outlook shows how interest rates affect commercial real estate through values and refinancing.
A going-in cap rate divides the first year's net operating income by the purchase price, and an exit cap rate is the rate a buyer assumes for the sale at the end of the hold. One building carries several cap rates at once, because each pairs a different year of income with a price.
Take the retail centre again, bought for $4,800,000 with one unit vacant. Every figure here is an assumption for the arithmetic.
| Cap rate | Income it uses | Calculation | Result |
|---|---|---|---|
| Trailing | NOI of the last 12 months | $297,600 / $4,800,000 | 6.2% |
| Going-in | NOI expected in year one | $312,000 / $4,800,000 | 6.5% |
| Stabilized | NOI once the vacant unit is leased | $336,000 / $4,800,000 | 7.0% |
| Exit, or terminal | NOI expected in year six | $350,000 / 0.07 | $5,000,000 sale price |
The agencies define stabilized income as "the yearly net operating income produced by the property at normal occupancy and rental rates" (interagency statement, valuation appendix). In a multi-year model, the exit rate turns the last year's income into a sale price, and the assumption is the buyer's own.
When a listing quotes a cap rate, ask which income and which price it uses. A seller's 7.0% and a buyer's 6.2% can describe the same building at the same price.
Appraisers determine a market cap rate from recent sales: each comparable sale's net operating income divided by its price gives one rate, and the range across those sales sets the rate for the property. The agencies expect that range to be tight: estimates of cap rates "generally should fall within a fairly narrow range for comparable properties" (interagency statement on loan workouts).
The OCC describes a second route: an overall rate "can be computed as a weighted average of component investment claims on NOI" (OCC handbook, glossary). The lender's share of the price earns the loan's payment rate, and the owner's share earns the return the owner asks.
A lender tests a commercial loan against the property's value and against its income, and the cap rate enters only the first test. Our lending guide explains what debt yield is: NOI divided by the loan amount. The OCC finds it "especially useful during periods of low interest and capitalization rates" (OCC handbook, debt yield).
The two tests meet in one identity: the share of value a debt yield test lends equals the cap rate divided by the debt yield. Take the retail centre's $312,000 of NOI and a lender with a 10% minimum debt yield and a limit of 75% of value. Both limits are assumptions.
| Market cap rate | Value | Loan at a 10% debt yield | Loan at 75% of value | Loan offered |
|---|---|---|---|---|
| 5.0% | $6,240,000 | $3,120,000 | $4,680,000 | $3,120,000, or 50% of value |
| 6.5% | $4,800,000 | $3,120,000 | $3,600,000 | $3,120,000, or 65% of value |
| 8.0% | $3,900,000 | $3,120,000 | $2,925,000 | $2,925,000, or 75% of value |
A fall in the cap rate from 6.5% to 5.0% lifts the value by $1,440,000, and the loan stays at $3,120,000. The buyer covers the whole difference in cash. Above a 7.5% cap rate the 75% limit takes over, because 10% times 75% is 7.5%. Run the payment on either loan in the commercial mortgage calculator.