There is no single "good" cap rate for commercial real estate. A good cap rate is one that fairly compensates you for the risk of that specific property: a higher cap rate usually signals more risk or less certain income, while a lower cap rate usually signals a safer, more stable property that buyers will pay more for. Whether a cap rate is good depends on property type, location, tenant strength, lease length, condition and your own return goals.
What a cap rate actually is
The capitalization rate (cap rate) is a property's annual net operating income (NOI) divided by its price or value. It is a snapshot of the income yield you would earn if you bought the property with all cash, before considering financing, taxes or future growth.
Hypothetical example: a building produces $210,000 in NOI and is offered at $3,000,000. The cap rate is $210,000 ÷ $3,000,000 = 7.0%. If you are unsure how to arrive at the NOI, start with how to calculate NOI for a commercial property.
Why there is no universal "good" number
Articles that name a single target cap rate overlook what the number actually measures. Two properties can have the same cap rate and very different risk, and two properties with different cap rates can both be fairly priced. Cap rates reflect what buyers in a particular market are willing to pay for a particular kind of income at a particular time. They move with interest rates, lending conditions, tenant demand and investor appetite. That is why we do not publish a "typical" cap rate for Northern Virginia here: the right number differs for a retail strip in Woodbridge, a flex building near Dulles, and an office property in Tysons, and it changes over time. To get a current, defensible range, use recent comparable sales from CoStar, a broker's analysis or an appraisal.
What pushes a cap rate higher or lower
| Factor | Tends to support a lower cap rate (lower perceived risk) | Tends to support a higher cap rate (higher perceived risk) |
|---|---|---|
| Tenant strength | Financially strong, established tenants | Small or unproven tenants, concentrated income |
| Lease term | Long remaining terms with rent increases | Short remaining terms or many near-term expirations |
| Location and demand | Strong access, visibility, limited competing supply | Weaker access, oversupply, softer demand |
| Property condition | Well maintained, modern systems | Deferred maintenance, large upcoming capital needs |
| Property type | Property types investors see as stable | Property types facing structural change or leasing challenges |
| Vacancy and rollover | Fully leased with staggered expirations | Significant vacancy or lease-up needed |
| Interest rates and lending | Low borrowing costs, abundant capital | Higher borrowing costs, tighter credit |
The pattern is consistent: more certainty about future income means buyers accept a lower yield, and more uncertainty means they demand a higher one.
How to decide what is good for you
Instead of asking whether a number is good in general, ask three practical questions.
- Is it consistent with comparable sales? Look at what similar properties sold for recently, using the same NOI definition. If a property is priced at a much lower cap rate than comparable sales, you may be overpaying; if it is higher, find out why.
- Does it cover my cost of capital? Compare the cap rate with your loan's interest rate. If the cap rate is lower than your borrowing cost, leverage may reduce rather than improve your cash flow. Hypothetical example: with a 6.5% cap rate and a loan at 7%, debt costs more than the property yields. Your lender and CPA can help model this.
- Is the NOI reliable? A cap rate is only as good as the NOI behind it. A cap rate based on a seller's pro forma can look better than one based on verified operating statements.
A worked comparison
Consider two hypothetical properties, both with $200,000 in NOI. The numbers are invented for illustration.
| Property A | Property B | |
|---|---|---|
| NOI | $200,000 | $200,000 |
| Asking price | $2,500,000 | $2,000,000 |
| Cap rate | 8.0% | 10.0% |
| Tenant and lease | One established tenant, 10 years remaining | Several small tenants, most leases expire within two years |
Property B has the higher cap rate, but it is not automatically the better buy. Its income is less certain, it may need leasing costs and tenant improvements, and its NOI could fall if tenants leave. Property A has the lower yield but more predictable income. Which one fits depends on your risk tolerance, financing, and plans for the property. This is why a cap rate works best as a starting point, not a verdict.
Cap rate versus other measures
- Cash-on-cash return: annual cash flow after debt service divided by cash invested. It reflects your financing, which cap rate ignores.
- Debt service coverage ratio (DSCR): NOI divided by annual loan payments. Lenders use it to size the loan.
- Price per square foot: useful for comparing similar buildings but ignores income.
- Internal rate of return (IRR): estimates total return over a holding period including resale, rent growth and capital costs.
Use cap rate alongside these measures. Our guide to evaluating a commercial real estate investment shows how the measures fit together.
Cap rate pitfalls to avoid
- Comparing cap rates built on different NOI definitions. One seller may include a management fee and reserves; another may not.
- Ignoring lease structure. NNN, modified gross and full-service leases produce different NOI for the same rent. See what a triple net lease is.
- Using going-in cap rate to judge growth. A below-market-rent building may have upside that the cap rate does not show.
- Forgetting about capital costs. A roof or parking lot replacement can erase years of apparent yield.
- Treating one comparable sale as the market. Look at several, and understand why each sold at its price.
How to get current cap rate data
Reliable sources include recent comparable sales reported in CoStar, an opinion of value from a broker who tracks the submarket, and a professional appraisal. Because we have access to CoStar, we can pull sales comparables for the property type and area you are considering. Our article on how to determine the market value of a commercial property explains how appraisers and brokers weigh this data.
This article is general education, not investment, tax or legal advice. Speak with your attorney, CPA and lender about your own situation.
Next step
If you want a second opinion on a property's price or cap rate, we are happy to review the numbers with you. Call 703-505-3501 or reach out through our contact page. To see what is available, browse our investment opportunities, shopping centers for sale in Northern Virginia and commercial real estate for sale in Northern Virginia.
Frequently asked questions
Is a higher cap rate better?
Not necessarily. A higher cap rate means more yield per dollar of price, but it often reflects more risk, such as shorter leases, weaker tenants or a challenging location. Compare risk and yield together.
What is the cap rate formula?
Cap rate equals net operating income divided by property price or value. For example, $150,000 of NOI on a $2,000,000 purchase is a 7.5% cap rate (a hypothetical illustration).
What cap rate should I expect in Northern Virginia?
It depends on the property type, submarket, tenant and lease terms, and it changes over time. We recommend using recent comparable sales from CoStar, a broker analysis or an appraisal rather than a general rule of thumb.
Does cap rate include mortgage payments?
No. Cap rate is based on NOI, which is calculated before debt service. It measures the property's income yield independent of financing.
How is cap rate used to value a property?
Divide NOI by a market cap rate to estimate value. Because small cap rate changes move value significantly, your cap rate should be supported by comparable sales.
What is the difference between cap rate and ROI?
Cap rate is a one-year, unleveraged yield. Return on investment can include financing, appreciation, resale proceeds and your total cash invested, so it is a broader measure.
Can the cap rate change after I buy?
Your purchase cap rate is fixed by the price and the NOI at that time. The cap rate you could sell at later depends on market conditions, and your own NOI can rise or fall as leases, expenses and occupancy change.
