What is a good cap rate?
There is no single good cap rate, because a cap rate is a price, not a grade: it is what a buyer pays today for a dollar of a property's net operating income. Whether a given rate is attractive depends on what risk-free alternatives yield, how much the income can grow, and how likely the income is to arrive, which is why stabilized assets with durable income trade at lower cap rates than older assets with shakier income. The useful questions are relative ones: how the rate compares to the ten-year Treasury yield, to the cost of the debt, and to closed trades on comparable properties with the NOI rebuilt on your own conventions.
A cap rate is a price, so good depends on which side you are on
A capitalization rate is net operating income divided by value, so a higher rate is a lower price per dollar of income. The identical number reads in opposite directions across the closing table: the buyer at a higher cap rate paid less for each dollar of income, and the seller collected less. Asking whether a cap rate is good without saying who is asking is like asking whether an interest rate is good without saying whether you are the borrower or the lender.
The market's rate is also not a judgment you get to argue with at the closing table. It is set by what similar buildings actually trade at. What you control is whether to transact at it, and whether the NOI underneath it is real, which is where most of the disagreement about any specific deal's cap rate actually lives.
| Cap rate | Implied value on 600,000 of NOI |
|---|---|
| 5.0% | 12,000,000 |
| 5.5% | 10,909,091 |
| 6.0% | 10,000,000 |
| 6.5% | 9,230,769 |
| 7.0% | 8,571,429 |
The spread over the risk-free rate is the anchor
Property income competes for capital with everything else, including a Treasury that pays out with no tenants, no roof and no calls at midnight. So a cap rate decomposes, loosely, into the risk-free yield, plus a premium for risk and illiquidity, minus something for expected income growth. Each piece moves in a direction you can reason about: higher risk-free yields push cap rates up, credible growth pulls them down, riskier income pushes them up.
This is why comparing a cap rate to a remembered cap rate misleads. A 6% cap is a wide spread when the ten-year Treasury yields 2% and a thin one when it yields 4.5%. The level means little without the spread, and the spread is the closest thing this question has to a scoreboard.
A cap rate at or below the risk-free yield is not automatically wrong. It is a specific claim that the income will grow fast enough to make up the gap, and it should be underwritten as that claim rather than accepted as a market fact.
Why asset class and market move it
Two properties with the same income are not the same asset. Income backed by hundreds of one-year apartment leases behaves differently from income backed by a single corporate tenant with seven years of term, and both behave differently from a hotel that re-lets every room nightly. Capital intensity matters too: a building that consumes a large share of its income in tenant improvements and re-leasing costs deserves a higher cap rate on the same NOI, because less of that NOI survives to the owner.
Markets price the same way. Deep, liquid markets with diversified employment trade tighter than small markets where the exit depends on a handful of local buyers. None of this produces a number for this page: current cap rates by class and metro move continuously, and the only source worth underwriting from is closed trades in your submarket whose NOI you have rebuilt yourself.
Going-in, stabilized, and exit are three different questions
The going-in cap rate is year-one NOI over the purchase price, and on a value-add deal it is depressed by exactly the problem you are buying: the vacancy, the below-market rents, the deferred maintenance. Judging that deal on its going-in cap is judging a renovation by the before photo. The stabilized measure, yield on cost, divides the NOI the plan should produce by everything it costs to get there, and comparing it against the market cap rate for the finished asset is the honest test of whether the work creates value.
The exit cap rate is an assumption about a market years away, and small changes to it move the outcome more than most operating assumptions. The usual institutional convention is to assume an exit 25 to 50 basis points above the going-in rate, because the building will be older and the future capital market is unknown. An underwriting that needs a tighter exit than its entry to work is relying on the market to improve, and should say so out loud.
How to judge the rate on your own deal
Three comparisons do most of the work. Against the risk-free yield, because the spread is your compensation for risk, illiquidity and effort, and it should be a number you can defend. Against the loan constant, because when the cap rate sits below the constant, borrowing lowers the year-one cash return instead of raising it, and the deal only works if the growth arrives. Against closed comparables, with each comp's NOI rebuilt on your own conventions, because a cap rate computed on a marketed pro forma is not the same statistic as one computed on actuals.
Altyst computes the going-in cap rate from the normalized NOI it builds out of the deal's documents, carries yield on cost for deals with a budget, and capitalizes the stabilized NOI at an exit cap you set and can stress, with base, upside and downside side by side. The free cap rate calculator on this site runs the single-ratio arithmetic in both directions, price to rate and rate to price, without an account.
Related questions
What is a good cap rate for a rental property?
No single number answers it across markets and years. A cap rate is what your market currently pays for a dollar of income, so the productive questions are relative: how the rate compares to the ten-year Treasury yield, whether it sits above or below your loan constant, and how it compares to closed trades on properties whose income quality matches yours.
Is a higher cap rate better?
For a buyer, a higher cap rate is a lower price per dollar of income, which is better only if the income is equally likely to arrive. Markets set higher cap rates on assets whose income is riskier, shorter, or more expensive to maintain, so an unusually high rate is a signal to investigate rather than a bargain to grab.
Why do cap rates rise when interest rates rise?
Because property income competes with bonds for the same capital. When risk-free yields rise, a property has to offer more yield to stay competitive, which means a higher cap rate and, on unchanged income, a lower price. The relationship is loose rather than mechanical, because expected growth and risk premiums move at the same time.
What is the difference between going-in and exit cap rate?
The going-in cap rate is year-one net operating income over the purchase price. The exit cap rate is applied to forward NOI at the end of the hold to estimate the sale price. The common convention is to assume an exit above the going-in rate, since the building will be older and the future market unknown; an underwriting that requires a tighter exit than its entry is relying on the market to improve.
Can a cap rate be below the interest rate on the loan?
Yes, and it happens in every cycle. When the cap rate sits below the loan constant, leverage is negative: each borrowed dollar reduces the year-one cash return rather than raising it, and the deal depends on income growth or a tighter exit. That is a position to take knowingly, not a detail to discover after closing.
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