The cap rate formula: NOI over value
Cap Rate = NOI / Property Value
Cap rate bands by property type and risk
| Cap Rate | Property Type | Implication |
|---|---|---|
| 4–5% | Trophy multifamily, prime industrial, top net-lease | Low risk, low yield, high prices |
| 5–7% | Quality multifamily, industrial, grocery-anchored retail | Moderate risk and return |
| 8%+ | Office (repriced sharply post-2022 remote-work shift), value-add, tertiary markets | High risk, distress-adjacent pricing |
Why lower cap rates mean higher prices
Lower cap rates mean higher prices (and lower yields). When investors say ‘cap rates are compressing,’ they mean property values are rising relative to income — real estate is getting more expensive.
Estimate a REIT's cap rate and its spread
Solving for value when cap rates rise
How interest rates transmit to property values
Reading what a falling cap rate implies
Decomposing the cap rate into its parts
Cap rates feel like a real-estate-specific number — yield divided by value, set by local market conditions. But the cap rate is actually tightly linked to the broader capital markets through a simple algebraic identity. Decomposing the cap rate into its components — risk-free yield, risk premium, and expected NOI growth — gives investors the bridge between real estate underwriting and the broader rate environment. Once you can decompose a cap rate, you can read what the market is implying about growth and risk, and you can spot when current pricing requires assumptions that may not hold.
Cap rate as risk-free yield plus premium minus growth
Cap Rate ≈ Risk-Free Yield + Risk Premium − Expected NOI Growth
The three drivers move independently
The three pieces move independently and can swap relative weights. Risk-free yield is set by the Treasury market. Risk premium is set by investor demand for real estate vs. other risk assets. Expected NOI growth is set by sector fundamentals (e-commerce drives industrial growth, remote work depresses office growth, etc.).
How rate and growth shifts move cap rates
| Environment | What happens to cap rates | What it means for property values |
|---|---|---|
| Falling rates, stable growth | Cap rates compress (lower) | Property values rise even at stable NOI |
| Rising rates, stable growth | Cap rates expand (higher) | Property values fall even at stable NOI |
| Stable rates, rising growth expectations | Cap rates compress | Property values rise on growth re-rating |
| Stable rates, falling growth expectations | Cap rates expand | Property values fall on growth de-rating |
When tight cap rate spreads are worth investigating
Cap rate compression below historical spread norms is a signal worth investigating, not an automatic warning. Tight spreads can reflect rising growth expectations (sustainable if growth materializes), falling risk premiums (vulnerable to a sentiment reversal), or both. The investor exercise is to identify which piece is doing the work.
The 2021-2023 industrial cap rate cycle
Compare a subsector's cap rate spread to history
Decomposing a tight apartment cap rate spread
Sit with the ideas.
An industrial property generates $720,000 in annual NOI. Comparable properties trade at a 6% cap rate. The 10-year Treasury yield is 4.5%. What is the implied property value, and what does the cap rate spread over Treasuries tell you?