Market
Cap rates & financing, explained
Updated
A capitalization (cap) rate is a property's net operating income divided by its price. If a building earns $100,000 a year in net operating income and sells for $1,500,000, the cap rate is 6.67%. Cap rates move with the cost of money, so investors watch benchmarks like the 10-year Treasury and SOFR.
Today's benchmarks
Benchmarks refreshed periodically, not live. Commercial loan pricing varies by lender, property and borrower.
How to calculate a cap rate
Cap rate = Net operating income ÷ Price. Net operating income (NOI) is rent and other income minus operating expenses (taxes, insurance, maintenance, management) the owner pays, before debt service. On a true NNN lease the tenant pays most expenses, so NOI is close to the base rent.
Why interest rates matter
- 10-year Treasury. A common reference for long-term fixed-rate commercial loans and for investors comparing real estate returns to a "risk-free" yield.
- SOFR. The Secured Overnight Financing Rate is the benchmark for many floating-rate and construction loans.
- 30-year mortgage rate. A residential benchmark, but a useful barometer of overall borrowing costs.
When borrowing costs rise, buyers usually need higher cap rates (lower prices for the same income) for deals to work with leverage. When they fall, the reverse tends to happen. Actual commercial loan terms vary by lender, property, tenant and borrower.
How I use this
The CCIM curriculum is built around this kind of analysis: discounted cash flow, debt coverage and the effect of financing on returns. I use it when pricing investment sales and sale-leasebacks, and I coordinate with your lender and CPA on financing.