What is Cap Rate (Capitalization Rate)?
The ratio of a property's net operating income (NOI) to its current market value or purchase price, expressed as a percentage.
Formula
Cap Rate = NOI ÷ Property Value
Cap Rate (Capitalization Rate) in commercial lending practice
Cap rate is a primary metric in CRE underwriting used to evaluate investment returns and compare properties across markets. A lower cap rate generally indicates lower perceived risk and higher property values; a higher cap rate signals higher risk or weaker market conditions. Cap rates compress in low-interest-rate environments and expand when rates rise. Credit analysts use cap rate trends to assess collateral value risk and refinancing assumptions over the loan term.
Worked example
Cap Rate (Capitalization Rate) in numbers
Setup
A stabilized 18,000 sq ft suburban office building generates underwritten NOI of $385,000. Three recent transactions in the same submarket traded at $4.4M (8.5% cap), $3.9M (8.8% cap), and $4.7M (8.2% cap). The appraisal applies an 8.6% cap rate to the subject NOI to derive value.
Calculation
Implied value = $385,000 ÷ 8.6% = $4,476,744
Sensitivity at 8.0% cap = $385,000 ÷ 8.0% = $4,812,500 (+7.5%)
Sensitivity at 9.5% cap = $385,000 ÷ 9.5% = $4,052,632 (-9.5%)
Interpretation
A 100 basis point move in cap rate moves value by roughly 10% in either direction. That sensitivity is why cap rate compression and expansion drive most of the loss content in CRE downturns — even with stable NOI, a value decline triggered by cap rate expansion can push LTV above policy at refinance. Credit memos for CRE in late-cycle markets should explicitly stress test value at a higher take-out cap rate.
Variations by loan type
How Cap Rate (Capitalization Rate) differs across CRE, C&I, and SBA
Multifamily
Tightest cap rate spreads of any asset class because of GSE liquidity (Fannie/Freddie). Class A urban multifamily can trade at 4.5%-5.5%; class B/C suburban typically 5.5%-7.0%. Cap rates compress most aggressively in low-rate environments and expand fastest when rates rise.
Office
Currently the most dispersed cap rate market: trophy CBD office can transact at 5.5%-6.5%, suburban class B at 7.5%-9.5%+, and distressed assets at 10%+ or sold below replacement cost. The credit memo should reference recent comps in the specific submarket, not national averages.
Industrial
Compressed dramatically through 2021-2022 (sub-5% on prime logistics) and re-priced wider since. Cap rate spreads now 5.5%-7.5% on most stabilized industrial. The narrower spread to multifamily reflects the credit and tenant-quality improvement of the asset class over the past decade.
Retail and hospitality
Retail varies dramatically: grocery-anchored at 6.0%-7.5%, power centers at 7.5%-9.0%, unanchored strip at 8.0%-10.0%+. Hospitality is the widest and most volatile, with cap rates moving 200+ basis points cycle-to-cycle. Both asset classes need particularly current comps in the credit memo.
Calculators
Run the math yourself
Further reading
Go deeper on Cap Rate (Capitalization Rate)
Frequently asked
Cap Rate (Capitalization Rate) FAQ
How is cap rate different from yield?
Cap rate is the ratio of NOI to property value. Yield (specifically debt yield) is the ratio of NOI to loan amount. They are mathematically related: at a given LTV, the loan's debt yield = cap rate ÷ LTV. Both are leverage-neutral and rate-neutral — they describe the property economics independent of how it is financed.
Why do cap rates move with interest rates?
Because investors price CRE relative to risk-free yields. As 10-year Treasury yields rise, investors require higher cap rates to compensate for the lower risk-adjusted spread. The relationship is not always 1:1 (cap rates lag in both directions and respond to capital flows and asset class fundamentals), but the directional link is reliable enough that cap rate stress testing on rate scenarios is standard practice.
What is a going-in cap rate vs an exit cap rate?
Going-in cap rate is calculated using the as-is NOI at acquisition. Exit cap rate is the cap rate the underwriter assumes for the sale or refinance at the end of the hold period. Standard underwriting assumes exit cap rate is at least 25-50 basis points wider than going-in (to be conservative), and stress scenarios push exit cap rate 100-150 basis points wider to test downside refi risk.
Can cap rate be used to value owner-occupied CRE?
It can be a useful sanity check, but it is not the primary valuation method for owner-occupied. Owner-occupied appraisals lean on cost approach and sales comparison, with the income approach (cap rate) used as a cross-check using market rents the property could command if leased to a third party. The credit memo on owner-occupied CRE should reconcile all three approaches if the appraisal includes them.
Related terms
Related concepts in commercial underwriting
NOI (Net Operating Income)
Total property revenue minus operating expenses, excluding debt service, capital expenditures, depreciation, and income taxes.
Read definitionCRE (Commercial Real Estate)
Real property used for business purposes, including office, retail, industrial, multifamily (5+ units), and hospitality properties.
Read definitionLTV (Loan-to-Value Ratio)
The ratio of the loan amount to the appraised value of the collateral property.
Read definitionDebt Yield
The ratio of a property's net operating income to the total loan amount, expressed as a percentage.
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