Cap rate (capitalization rate) is the annual return a property generates from its operations, expressed as a percentage of property value. It's the most universal way to compare deals across markets, property types, and price points.
Cap rate ignores financing. It measures the property's performance on its own merits — useful when comparing deals where you'll use different loan structures.
| Market Type | Typical Cap Rate | Examples |
|---|---|---|
| Tier 1 / High Growth | 3-5% | San Francisco, NYC, Boston, Seattle |
| Tier 2 / Balanced | 5-7% | Austin, Denver, Charlotte, Nashville |
| Tier 3 / Cash Flow | 7-10% | Cleveland, Memphis, Indianapolis, KC |
| Tier 4 / High Yield | 10%+ | Rural markets, small towns, distressed assets |
Lower cap rate doesn't mean a worse deal. High-growth markets trade on appreciation, not yield. Cash flow markets trade on monthly returns, not appreciation. Pick your strategy first, then evaluate cap rate against that strategy's benchmark.
Cap rate and cash-on-cash return are different metrics that answer different questions:
If you finance 80% of a deal, your cash-on-cash return will typically exceed your cap rate (positive leverage). If interest rates exceed the cap rate, your cash-on-cash will be lower than cap rate (negative leverage). Use cap rate to evaluate the property; use cash-on-cash to evaluate your specific deal structure.
Depends on the market. 8%+ is strong in cash-flow markets like the Midwest. 5-6% is typical in balanced markets. 3-5% is common in high-growth coastal markets where appreciation dominates. Compare to recent sold comps in the same submarket — that's your benchmark.
For purchase decisions, use trailing 12-month (T-12) actual income. Pro forma assumes everything goes right and rarely does. T-12 is harder to manipulate. If T-12 isn't available, request rent rolls and trailing operating statements.
No — cap rate measures current yield, not future appreciation. Low cap rate markets historically appreciate faster but cycle harder. High cap rate markets appreciate slower but provide more reliable cash flow. The trade-off is intentional.
DSCR lenders care about NOI ÷ debt service (DSCR), not cap rate directly. But a higher cap rate property generates more NOI relative to its value, which typically supports higher LTV and better DSCR. Properties with cap rates above market median qualify for the best terms.
Yes — cap rate math is identical for residential, multifamily, and commercial real estate. Commercial properties typically trade at higher cap rates than residential due to different risk and management profiles.