If you’ve ever frozen when someone in a deal room says, “That property is trading at a 6 cap,” this one’s for you.
Cap rate (short for capitalization rate) answers one question: how much income does this property produce relative to what it costs? That’s it. Strip away the acronym, and it’s just a yield measurement, the same way you’d think about the interest rate on a savings account, except the “interest” here is the property’s net income.
The formula is simple: Net Operating Income divided by Purchase Price.
Say a building generates $60,000 a year after operating expenses (but before the mortgage payment), and it costs $1,000,000 to buy. Divide $60,000 by $1,000,000, and you get 6%. That property is trading at a 6 cap.
Here’s the part most explanations skip: Cap rate is really a stand-in for risk and growth expectations, not just a return number. A lower cap rate (say 4%) usually means buyers see the property as safer or expect rent growth; think a newer apartment building in a thriving city. A higher cap rate (say 8%) usually means buyers want to be paid more for taking on risk; think an older property in a market with question marks. Cap rate isn’t telling you a property is “good” or “bad.” It’s telling you what the market thinks about its risk.
This is also why the cap rate moves when interest rates move. When borrowing gets more expensive, buyers need a bigger income cushion to make the math work, so cap rates tend to rise, and prices tend to fall to compensate. When rates ease, the opposite happens. CBRE is actually forecasting cap rates to compress 5 to 15 basis points across most property types in 2026, which is a quiet signal that buyers are willing to pay a bit more for the same income stream than they were last year.
One thing the cap rate does NOT tell you: your actual return as an investor. It ignores the mortgage entirely, which means it says nothing about cash flow after debt service, appreciation, or tax benefits. A property’s cap rate and your personal return on that deal can look completely different once leverage enters the picture.
Simple version to remember: Cap rate is the unlevered yield. It tells you what the property earns relative to its price, and what the market thinks about how risky that income is. Nothing more, nothing less.
What’s a real estate term you’ve always wanted explained without the jargon? Drop it below, and I’ll cover it in a future issue.
