A good cap rate in commercial real estate typically falls between 5% and 10%, but the right number depends heavily on property type, location, and your investment goals. A 4% cap rate on a Class A office building in a major metro could be a strong deal, while a 9% cap rate on a rural retail property might signal more risk than reward. The cap rate is simply your expected annual return based on the property’s net operating income divided by its purchase price, so understanding what drives that number up or down is more useful than chasing a single target.
How Cap Rates Work
The capitalization rate measures a property’s unleveraged yield. You calculate it by dividing the property’s net operating income (the rent collected minus operating expenses, before any mortgage payments) by the purchase price. A building generating $100,000 in net operating income that sells for $1.25 million has a cap rate of 8%.
What trips up many investors is the inverse relationship between cap rates and prices. A lower cap rate means you’re paying more per dollar of income, which typically reflects a safer, more desirable asset. A higher cap rate means you’re paying less per dollar of income, but you’re usually taking on more risk: shorter lease terms, weaker tenants, older buildings, or less desirable locations. Neither end is inherently better. It depends on whether you’re prioritizing stable cash flow or higher returns with more volatility.
Typical Ranges by Property Type
Different property types carry different risk profiles, and cap rates reflect that. Here’s where you’ll generally see them land:
- Multifamily apartments: 4% to 7%. Apartments benefit from consistent demand and shorter lease cycles that allow rents to adjust with inflation. Institutional-quality complexes in strong rental markets trade at the lower end.
- Industrial and warehouse: 4.5% to 7%. The boom in e-commerce logistics has compressed industrial cap rates significantly over the past decade, making these among the most aggressively priced asset classes.
- Office: 5.5% to 9%. Office cap rates have widened in many markets due to remote work trends and rising vacancy. Well-leased suburban medical office buildings tend to trade tighter than traditional downtown office towers right now.
- Retail: 5% to 9%. Single-tenant retail properties leased to credit-worthy national tenants (pharmacies, grocery stores) can trade below 6%, while strip malls with local tenants in secondary markets often land above 8%.
- Hotels and hospitality: 7% to 12%. Hotels carry the highest operational risk because revenue resets nightly, so investors demand higher returns.
Why Location Moves the Number
A property’s market tier is one of the biggest drivers of its cap rate. Class A properties in major metros with deep tenant pools, strong population growth, and diverse economies command the lowest cap rates because investors view them as the safest places to park capital. The same building type in a smaller secondary or tertiary market will trade at a noticeably higher cap rate, sometimes 150 to 300 basis points higher (1.5 to 3 percentage points), to compensate for thinner demand and higher vacancy risk.
This spread exists because institutional buyers, pension funds, and foreign capital all compete for properties in top-tier cities, driving prices up and cap rates down. In smaller markets, the buyer pool is narrower, which gives individual investors more negotiating leverage but also means the property may be harder to sell later. If you’re seeing an unusually high cap rate on what looks like a solid building, ask yourself why the market isn’t pricing it tighter. The answer usually comes down to location risk, tenant quality, or deferred maintenance.
Property Quality and Tenant Strength
Class A properties, the newest and best-maintained buildings with top-tier finishes, carry the lowest cap rates because they attract the strongest tenants on longer leases. Class B properties, solid but older or less updated, typically trade 100 to 200 basis points higher. Class C and D properties can offer significantly higher cap rates, sometimes north of 9% or 10%, but they come with higher vacancy, more tenant turnover, and larger capital expenditure needs.
Tenant creditworthiness matters just as much as the building itself. A single-tenant industrial building leased for 15 years to a publicly traded company is priced very differently from the same building leased month-to-month to a small local business. The length and quality of the lease essentially determines how bond-like the income stream is. Longer leases to stronger tenants compress the cap rate; shorter leases to riskier tenants push it higher.
Cap Rates and Interest Rates
Cap rates don’t move in a vacuum. They’re influenced by the broader interest rate environment, particularly the yield on 10-year Treasury bonds. Investors compare the return they can earn on a risk-free Treasury to the return on a commercial property and demand a spread, or premium, for taking on real estate risk.
That spread has historically averaged around 342 basis points (3.42 percentage points) between 1991 and 2019, according to CBRE Investment Management. As of the third quarter of 2025, the spread sits at just 172 basis points, placing it in the 24th percentile since 1965. In practical terms, this means commercial property is priced aggressively relative to Treasuries. Spreads below 200 basis points have only occurred about 30% of the time over the past six decades.
When cap rate spreads are narrow, your margin of safety is thinner. If interest rates rise or property values soften, there’s less cushion protecting your return. This doesn’t mean you should avoid buying, but it does mean you should stress-test your deal: if cap rates widen by 50 or 100 basis points over your hold period, does the investment still work?
What Makes a Cap Rate “Good” for You
The right cap rate depends on your strategy. If you’re a conservative investor looking for steady, predictable income with minimal management headaches, a 5% cap rate on a well-leased multifamily or industrial property in a strong market might be ideal. You’re trading higher yield for lower risk and better long-term appreciation potential.
If you’re a value-add investor willing to renovate, re-tenant, or reposition a property, you might target an 8% or 9% going-in cap rate with the plan to compress it to 6% or 7% after improvements. The difference between where you buy and where you could sell, sometimes called cap rate compression, is where a large portion of the profit comes from in these deals.
A few practical checks help you evaluate whether a specific cap rate makes sense:
- Compare to similar sales: Look at recent comparable transactions in the same submarket for the same property type. If the average is 6.5% and you’re buying at 5%, you need a compelling reason.
- Check your debt cost: If your mortgage interest rate is higher than the cap rate, you have negative leverage, meaning financing the property actually drags down your cash-on-cash return rather than amplifying it.
- Factor in capital needs: A high cap rate loses its appeal quickly if the roof needs replacing next year. Deferred maintenance can turn an attractive yield into a money pit.
- Consider your exit: If you plan to sell in five to seven years, think about what cap rates might look like at that point. Buying at historically tight cap rates with the assumption they’ll compress further is a bet that doesn’t always pay off.
A “good” cap rate ultimately isn’t a single number. It’s the rate that fairly compensates you for the risk you’re taking, covers your cost of capital, and aligns with your hold period and return targets. Two investors can look at the same property, one buying at a 5% cap rate for stable cash flow and the other passing because it doesn’t meet their 8% threshold, and both can be making the right decision for their portfolio.