Cap rate is the single most quoted number in commercial real estate, and also one of the most misunderstood. As of Q1 2026, the average single tenant net lease property traded at a 6.80% cap rate, according to The Boulder Group’s net lease research, a figure brokers repeat constantly without always explaining what it measures.
At its core, a cap rate is a way to standardize the expected yield of a property so it can be compared against other deals, against other asset classes, and even against a government bond, regardless of how any individual buyer finances the purchase. Because the calculation uses net operating income and price alone (with no mortgage), it expresses an unlevered yield.
The problem is that if you’re new to commercial real estate, those first two paragraphs might have flown right over your head.
In this article, we’ll cover what a cap rate is, how to calculate it, what counts as a good one, why the number moves with interest rates, and what it cannot tell an investor on its own.
Key Takeaways
- ▸A cap rate is a property’s annual net operating income divided by its price or value, expressed as a percentage.
- ▸It measures the unlevered yield an asset produces at a single point in time, which lets investors compare opportunities on equal footing.
- ▸Higher cap rates generally signal higher risk and higher potential return, and lower cap rates the reverse.
- ▸The number is a starting point, not a verdict.
What Is a Cap Rate?
A cap rate, short for capitalization rate, is the unlevered annual rate of return a property would produce if it were purchased in cash. It equals net operating income divided by market value, expressed as a percentage, and it lets investors gauge both yield and relative risk at a single moment in time.
The comparison investors reach for most often is a bond. Much like the coupon on a bond expresses an annual payment as a percentage of the asset’s value, a cap rate expresses a property’s annual income as a percentage of its price, as Plante Moran notes.
A property worth $10M that generates $500,000 of net operating income carries a 5% cap rate. Buy the same income stream for less, and the cap rate rises; pay more, and it falls.
What makes the metric portable is what it doesn’t calculate. A cap rate ignores financing entirely, which is why it is described as “unlevered.” Two investors can buy the identical building, one in cash and one with a large mortgage, and the property still carries the same cap rate for both because the calculation never touches the debt. That property is then comparable, on a single yield figure, to a medical office across town or an apartment complex in another state.
Your financing terms might materially change what the deal looks like for you, but the rest of the investing world can use this metric to compare yield on different properties.
How Do You Calculate a Cap Rate?
To calculate a cap rate, divide a property’s annual net operating income by its current market value or purchase price, then express the result as a percentage. Net operating income is rental income after operating expenses but before any debt service, so the figure measures the property’s performance, not the buyer’s loan.
Net operating income, usually shortened to NOI, is where the work happens. It begins with the income a property collects, then subtracts operating expenses such as property taxes, insurance, maintenance, and management. It deliberately excludes mortgage payments and interest, since the cap rate is meant to measure the asset on an unlevered basis, as Commercial Real Estate Loans explains.
A worked example keeps it concrete.
Illustrative scenario:
Suppose an industrial property is listed at $2M and produces $100,000 of NOI. Dividing $100,000 by $2M gives 0.05, or a 5% cap rate.
If that same building runs at 90% occupancy rather than full, effective income falls to roughly $90,000 and the cap rate drops to about 4.5%, a reminder that the assumptions behind NOI matter as much as the formula itself, as LoopNet points out.
Because NOI shifts as rents rise, tenants turn over, or expenses change, a cap rate is never truly fixed. It is a snapshot, accurate for the moment it is calculated and worth recalculating as the inputs move.
What Counts as a Good Cap Rate?
There is no universal good cap rate. The right number depends on the asset class, the market, and the risk involved. Most commercial properties trade somewhere between 4% and 10%, with investors focused on cash flow often seeking 6% or higher and buyers in appreciation markets accepting 4% to 5%, according to CapRateKit.
The instinct to chase the highest cap rate available is understandable, since a higher number means more income relative to price and a faster theoretical payback. A 10% cap rate, for instance, implies recovering the purchase price in roughly ten years from income alone, as Benzinga describes. The appeal of that math is obvious, and worth acknowledging before we complicate it.
The complication is that a higher cap rate generally comes with higher risk. It may reflect a weaker local economy, higher vacancy, a less reliable tenant, or a shorter lease, any of which can erode the income the cap rate assumes. A lower cap rate, by contrast, typically signals a safer, steadier asset that buyers are willing to pay a premium to own. The bond comparison holds here too: a Treasury yields less than a speculative corporate bond precisely because it is safer, and cap rates sort risk in much the same way.
Asset class drives a good share of the spread. Necessity retail, certain industrial, and stabilized multifamily tend to trade tighter, while sectors carrying more operational or demand risk price wider. Even within a single category the range is broad, which is part of what makes a niche like investing in gas station real estate worth understanding on its own terms before reading any one cap rate as good or bad.
Learn More About Working with Custom Capital →
Why Cap Rates Move: Interest Rates and Risk
Cap rates do not sit still, and the force that moves them most reliably is the cost of money. When interest rates rise, financing gets more expensive and buyers can afford to pay less for the same income, which pushes cap rates up and values down. When rates fall, capital competes more aggressively for property and cap rates compress, as both AmeriSave and JPMorgan describe. The adjustment is rarely instant; it tends to play out over six to eighteen months as the market digests the change.
A useful way to read a cap rate is as a spread over a risk free benchmark, usually the yield on the 10 year Treasury note. The gap between the two is the risk premium, the extra return an investor demands for owning property instead of a government bond. Historically that spread has run around 2% to 3% in normalized conditions, according to Wall Street Prep, and many buyers want the cap rate to exceed their borrowing cost by 200 to 300 basis points before a deal pencils, as HelloData notes.
That framing explains the current market. With the 10 year Treasury averaging roughly 4.38% at the end of Q1 2026, net lease assets were still offering a premium over Treasuries, according to InvestmentGrade. When financing costs sit below the cap rate, positive leverage returns, meaning borrowed money amplifies the cash return rather than dragging on it. This is where access to financing terms becomes a competitive factor in its own right. At Custom Capital, that edge is a programmatic institutional lending facility, which can affect whether a given cap rate produces positive leverage at all. Buyers moving capital through a 1031 exchange feel this directly, since the financing on the replacement property shapes the return as much as the cap rate on the purchase.
Cap Rates Across NNN and Net Lease Properties
Single tenant net lease properties averaged a 6.80% cap rate in Q1 2026, with retail near 6.55%, industrial at 7.15%, and office wider at 7.90%, according to The Boulder Group. Within that average, pricing splits sharply by tenant credit and lease term, so two properties at the same headline cap rate can carry very different risk.
The clearest illustration is tenant quality. Trophy names with the strongest credit trade at the tightest cap rates: a McDonald’s ground lease changed hands around a 4.40% cap rate in Q1 2026, with Chick-fil-A close behind near 4.50%, according to Neuhaus Realty Group’s net lease overview. Solid mid tier credit tenants such as AutoZone, Dollar General, and 7-Eleven generally price in the 5.5% to 6.5% range, depending on location and remaining term.
Lease term matters just as much as the logo on the building. Boulder’s Q1 2026 data shows Walgreens properties with 15 to 19 years of remaining term priced around 6.75%, while Walgreens locations with under five years left were shown near 9.25%, according to InvestmentGrade. Same tenant, same brand, roughly 250 basis points of difference, driven almost entirely by how long the income is contracted.
This is why a cap rate on a single tenant property is best read as the visible price of a bundle of risks: tenant credit, lease length, rent escalations, and the underlying real estate.
Strong credit paired with a long lease and the low landlord obligations of single tenant NNN properties is a different asset from a short lease with a weaker guarantor, even at an identical cap rate.
If you’re a brand new accredited investor who’s just getting started with commercial real estate investing and would like a representative from our team to help…
SPEAK WITH A REPRESENTATIVE FROM CUSTOM CAPITAL →
What a Cap Rate Cannot Tell You
For all its usefulness, a cap rate answers exactly one question, and investors get into trouble when they ask it to answer more. Because it is unlevered, it says nothing about the return a specific buyer will actually earn once a mortgage is involved. Add financing to the picture and the cash on cash return can land well above or well below the cap rate, depending on the loan, as The Cauble Group explains.
It is also silent on time. A cap rate is a single point in time snapshot that does not account for the time value of money, future rent growth, capital improvements, or the eventual sale price, which is why it sits alongside, rather than replaces, metrics such as cash on cash return and internal rate of return, according to Plante Moran. A property’s full return story usually needs all three.
None of this makes the cap rate less valuable; it makes it a starting point rather than a conclusion. The strongest deals, many of which never reach a public listing, tend to reward investors who treat the cap rate as the first question and the lease, credit, financing, and real estate as the ones that follow. Understanding how the best off market NNN properties get sourced is often where that deeper diligence begins.
The Bottom Line on Cap Rates
For all the weight it carries in commercial real estate, a cap rate is a clean idea: annual income divided by price, expressed as a yield that lets one property be compared to the next regardless of financing. A few principles hold across almost every deal. Higher cap rates generally mean more risk, not simply more reward. The number moves with interest rates and reads most clearly as a spread over the Treasury yield. And it captures only a moment, leaving leverage, time, and the quality of the underlying lease for the investor to weigh.
Where a cap rate looks attractive, the productive next step is pressure testing the lease, the tenant credit, and the price behind it.
Put a Cap Rate to the Test
For accredited investors who would rather have that diligence handled by a dedicated team, Custom Capital has acquired more than $425M in real estate.
Schedule a call if you’re an accredited investor who’s looking for white-glove service:
Frequently Asked Questions
What is a cap rate in simple terms?
A cap rate is the annual return a property would produce if bought in cash, calculated as net operating income divided by price and shown as a percentage. A $1M property earning $60,000 in net operating income has a 6% cap rate. It is a quick way to compare the yield of different properties, as Plante Moran describes.
What is the difference between a cap rate and an interest rate?
A cap rate is the unlevered yield a property produces, while an interest rate is the cost of borrowing to buy it. The two are closely linked: when interest rates rise, cap rates generally rise as well, and investors typically want the cap rate to exceed their borrowing rate, often by 200 to 300 basis points, to keep cash flow positive, according to HelloData.
What is a good cap rate?
There is no single good cap rate, since the right level depends on asset class, location, and risk. Most commercial properties trade between 4% and 10%, with income focused buyers often targeting 6% or more and buyers prioritizing appreciation accepting 4% to 5%, as CapRateKit notes. A lower cap rate is not automatically a worse deal; it often reflects a safer asset.
Does a higher cap rate mean a better deal?
Not necessarily. A higher cap rate means more income relative to price, but it usually reflects higher risk, such as a weaker tenant, a shorter lease, or a softer market, according to AmeriSave. A lower cap rate often signals a safer, more stable property. The right cap rate is the one that matches the risk an investor is willing to hold.
What is the difference between cap rate and cash on cash return?
A cap rate measures a property’s unlevered yield and ignores any mortgage, while cash on cash return measures the actual cash income an investor earns relative to the cash they put in, after financing. Because of leverage, the two can differ widely on the same property, which is why investors use both, as The Cauble Group explains.
