Cap rate (capitalization rate) is calculated as a property's net operating income (NOI) divided by its purchase price or current market value, expressed as a percentage. It's the most commonly used shorthand for comparing investment returns across industrial properties — lower cap rates generally reflect lower perceived risk and stronger long-term demand, while higher cap rates reflect higher risk or lower growth expectations.
The cap rate formula
| Variable | Definition |
|---|---|
| Cap Rate | Net Operating Income ÷ Property Value |
| Example | $500,000 NOI ÷ $8,000,000 value = 6.25% cap rate |
What drives cap rates up or down
Cap rates compress (go lower) in markets and asset classes investors consider safer or higher-growth — modern Class A distribution facilities in supply-constrained coastal markets often trade at some of the lowest industrial cap rates. Cap rates expand (go higher) for older buildings, secondary or tertiary markets, shorter remaining lease terms, or weaker tenant credit, all of which increase perceived risk.
Interest rates also move cap rates broadly across the market — rising rates generally push cap rates up (and property values down) since investors can get comparable returns from lower-risk assets, while falling rates tend to compress cap rates.
What to watch for before committing
NOI calculation accuracy
Confirm the NOI used in a cap rate calculation reflects actual, sustainable income — not an inflated pro forma figure.
In-place vs market cap rate
Distinguish between a property's cap rate based on current in-place rents versus one based on projected market rent increases.
Tenant credit and lease term
A single-tenant property with a weak-credit tenant on a short remaining lease term should trade at a higher cap rate to reflect that risk.
Market comparability
Only compare cap rates within the same asset class and market tier — a coastal Class A cap rate isn't comparable to a secondary-market Class C figure.
Interest rate environment
Cap rates move with broader interest rate trends — a cap rate that looked attractive a year ago may not reflect current market pricing.
Capital expenditure needs
A low cap rate on a property with major deferred maintenance may not reflect the true return once necessary capital improvements are factored in.
When you need to know this
- Evaluating an investment purchase — comparing a property's return potential against other opportunities in the market
- Sale-leaseback analysis — understanding how a property will be valued when negotiating a sale-leaseback transaction
- Portfolio benchmarking — tracking how cap rates for owned assets compare to current market pricing
- Market cycle timing — gauging whether current cap rate levels suggest a buyer's or seller's market
Frequently asked questions
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