What a cap rate tells you
The cap rate tells you how much income a property produces compared to its price. A higher cap rate usually means more perceived risk and more potential return; a lower cap rate means less risk (or a more desirable asset/location) and less return. Cap rate is how investors compare very different buildings on a single, common scale.
Cap Rate
Cap Rate = NOI ÷ Property Value
- NOI
- — Net Operating Income (annual)
- Property Value
- — Purchase price or appraised value
Worked example: A building has $300,000 NOI and sells for $5,000,000. Cap Rate = $300,000 ÷ $5,000,000 = 6%.
The other direction: solving for value
Flip the formula around and you get direct capitalization — the most common way commercial properties are valued: Value = NOI ÷ Cap Rate. This is why cap rate movements matter so much: for a fixed NOI, a lower cap rate means a *higher* value, and a higher cap rate means a *lower* value. A small change in the cap rate can swing a property's value by a large dollar amount.
The same $300,000 NOI at different cap rates
| Cap Rate | Implied Value |
|---|---|
| 4% | $7,500,000 |
| 5% | $6,000,000 |
| 6% | $5,000,000 |
| 7% | $4,285,714 |
| 8% | $3,750,000 |
Going-in cap rate vs. exit cap rate
The going-in cap rate is the cap rate at purchase (NOI at acquisition ÷ purchase price). The exit cap rate is the assumed cap rate used to estimate the sale value when the investment is eventually sold (projected NOI at sale ÷ exit cap rate). Investors often assume the exit cap rate will be *higher* than the going-in cap rate ("cap rate expansion") as a conservative cushion — assuming otherwise can make a mediocre deal look artificially attractive.
Why cap rates move: risk and interest rates
Cap rates compress (fall) when capital is abundant, interest rates are low, and buyers see less risk — pushing prices up for the same NOI. Cap rates expand (rise) when rates rise, credit tightens, or the market perceives more risk — pushing prices down for the same NOI. This is the core link between the bond market and commercial real estate values: as the risk-free rate rises, investors generally demand a higher cap rate to compensate, all else equal.
Try it: watch value react to cap rate and NOI
Adjust NOI, price, and market cap rate — see the resulting cap rate, implied value, and a full sensitivity table.
Cap Rate Simulator
Change NOI and price to see the cap rate move, and see how the same NOI is valued at different market cap rates.
Resulting Cap Rate
6.00%
NOI ÷ Property Value
Sensitivity: what would this exact $300,000 NOI be worth at other market cap rates?
| Cap Rate | Implied Value |
|---|---|
| 4.00% | $7,500,000 |
| 5.00% | $6,000,000 |
| 6.00% (current) | $5,000,000 |
| 7.00% | $4,285,714 |
| 8.00% | $3,750,000 |
Notice that value and cap rate always move in opposite directions for a fixed NOI — a lower cap rate means a higher value (cap rate compression), and a higher cap rate means a lower value (cap rate expansion).
Module Check
You are advising a seller. Market cap rates have expanded 150 basis points since they purchased, but the property's NOI hasn't changed.
A property's NOI stays flat at $400,000, but the market cap rate expands from 5% to 6.5%. What happens to the property's implied value?