What Is a Cap Rate?
The capitalization rate (cap rate) is the most fundamental metric in commercial real estate underwriting. It measures the annual return a property generates relative to its purchase price, assuming an all-cash purchase with no financing. Cap rate is calculated as:
What Is a Good Cap Rate in 2026?
A "good" cap rate depends entirely on your market and investment strategy. In high-cost coastal markets like the San Francisco Bay Area, Los Angeles, or New York, cap rates of 3.5–5% are common because investors are buying appreciation, not yield. In cash-flow markets like the Midwest or Southeast, investors typically target 7–10%+ cap rates.
- Below 4%: Compressed. Common in gateway cities. Appreciation play, not income.
- 4–6%: Market rate for most major metros in 2026.
- 6–8%: Strong yield. Typical in secondary markets.
- 8%+: High yield. Common in tertiary markets or value-add deals.
Cap Rate vs. Cash-on-Cash Return
Cap rate ignores financing — it's a property-level metric. Cash-on-cash return accounts for your actual mortgage payments and measures the yield on your invested equity. A property with a 6% cap rate might produce a 9% cash-on-cash return with leverage, or a 3% return if interest rates are high. CCIM-trained analysts always look at both.
Cap Rate and Interest Rates
Cap rates and interest rates are closely linked. When the 10-year Treasury rises, cap rates tend to expand (prices fall) to maintain spread. In 2022–2024, the Fed rate hike cycle compressed spreads significantly — many CRE assets saw cap rates below their borrowing cost, creating negative leverage. In 2026, normalization is underway but spreads remain tight in gateway markets.
How to Calculate NOI
Net Operating Income = Gross Potential Rent − Vacancy Loss − Operating Expenses. Operating expenses include property taxes, insurance, maintenance, property management fees, and utilities (if owner-paid). NOI does NOT include mortgage payments, depreciation, or income taxes.