What’s a Good Cap Rate for Commercial Property?

When you hear investors talk about a good cap rate, the phrase usually hides a lot of numbers, local market quirks, and risk assessments. Figuring out whether a cap rate is attractive for a commercial property isn’t just a math problem - it’s a decision that blends data with strategy.

Key Takeaways

• Cap rate = Net Operating Income ÷ Purchase Price.
• Higher cap rates signal higher expected returns but also higher risk.
• Typical ranges in 2025: office 5‑7%, retail 6‑8%, industrial 7‑9%, multifamily 4‑6%.
• Location, lease quality, and tenant credit drive the "good" number.
• Use a step‑by‑step calculation and compare against market benchmarks before committing.

Understanding Cap Rate

Cap Rate is a shorthand for the rate of return on a real‑estate investment based on the property’s net operating income (NOI) and its purchase price. The formula is simple:

Cap Rate = NOI ÷ Purchase Price × 100%

NOI itself is the gross rental income after you subtract operating expenses (property management, insurance, taxes, maintenance, but not mortgage payments). Because the cap rate strips out financing, it lets investors compare properties regardless of how they plan to fund the deal.

How Cap Rate Relates to Commercial Property Value

Commercial Property refers to any real‑estate used for business purposes - office buildings, shopping centers, warehouses, multifamily apartments, and the like. For these assets, the cap rate is the bridge between the income they generate and the price an investor is willing to pay. If a property yields $500,000 in NOI and you buy it for $7.5 million, the cap rate works out to 6.7 %. That 6.7 % becomes a benchmark you can compare with other deals in the same market.

Factors That Influence a Good Cap Rate

• Location: Prime downtown assets usually have lower cap rates because they attract stable, credit‑worthy tenants.
• Property Type: Industrial warehouses tend to command higher caps than office towers due to differing risk profiles.
• Lease Structure: Long‑term, triple‑net leases (NNN) lower perceived risk, pulling the cap rate down.
• Tenant Credit Quality: A REIT or Fortune‑500 tenant boosts confidence, often nudging the cap rate lower.
• Market Conditions: In a low‑interest‑rate environment, investors accept lower caps because financing is cheap.
• Operating Expenses: Efficient property management can improve NOI, raising the cap rate without changing price.
• Capitalization Rate Market Trends: Regional cap rate surveys published by brokerage firms give a snapshot of what’s considered "normal" for each asset class.

Typical Cap Rate Ranges by Property Type (2025)

Notice how the ranges shift depending on risk and tenant stability. When you encounter a property that offers a cap rate outside the usual band, dig deeper - it could be a hidden opportunity or a red flag.

Calculating Your Own Cap Rate - A Step‑by‑Step Example

1. Gather the property’s annual gross rental income. Example: $1,200,000.
2. Subtract operating expenses (property tax $80,000, insurance $30,000, maintenance $50,000, management $40,000). Total expenses = $200,000.
3. Calculate NOI: $1,200,000 - $200,000 = $1,000,000.
4. Determine the purchase price (or market value). Example: $14,500,000.
5. Apply the cap rate formula: ($1,000,000 ÷ $14,500,000) × 100% ≈ 6.9%.

A 6.9 % cap sits comfortably in the office average range, suggesting the deal is priced fairly if the tenant mix and lease terms are typical for the region.

Interpreting Results: What Makes a Cap Rate “Good”?

There’s no universal magic number. A “good” cap rate is the one that meets your investment goals while fitting the risk you’re willing to shoulder. Here are two quick lenses to decide:

• Yield‑Focused Lens: If you need a 7 % cash‑on‑cash return, look for caps at or above that level, assuming minimal financing.
• Risk‑Adjusted Lens: Compare the cap to the local market average. A cap 1‑2 % points above the average may compensate for higher vacancy risk or a weaker tenant.

Remember that the cap rate ignores debt. If you finance the purchase at a 5 % interest rate, a 6 % cap still only leaves a 1 % spread before taxes and other costs.

Common Pitfalls and How to Avoid Them

• Ignoring Vacancy: Some sellers quote NOI at 100 % occupancy. Adjust the income for realistic vacancy rates.
• Mixing Operating and Debt Costs: Cap rate should be calculated before mortgage payments. Including them skews the metric.
• Over‑relying on One Survey: Cap rate benchmarks vary between brokerages. Cross‑check at least two sources.
• Neglecting Future Capital Expenditures: Large upcoming repairs can depress NOI and inflate the cap rate.