What’s a Good Cap Rate? It Depends – Here’s Why

Cap rates are one of the most commonly referenced metrics in real estate investing, and one of the most misunderstood. Investors often ask, “What’s a good cap rate?” expecting a quick, one-size-fits-all answer.

But the truth is more complicated.

A “good” cap rate depends on a range of variables, from asset class and location to tenant quality and market conditions. In this blog, we’ll explore why cap rates vary so widely, what actually influences them, and how investors can use cap rates more intelligently when evaluating potential deals.

Why Cap Rates Vary

The capitalization rate represents the ratio of a property’s net operating income (NOI) to its purchase price or market value. It’s often used as a quick way to estimate a property’s return, assuming no debt is involved.

However, a cap rate is not an isolated number; it reflects risk, market dynamics, and investment strategy. Two properties with identical income could have very different cap rates, depending on a range of factors.

Let’s break down the 7 most important factors:

1. Asset Class

Not all property types are priced the same. Cap rates can differ dramatically across asset classes due to differences in stability, demand, and income volatility.

• Multifamily properties tend to have lower cap rates because of steady demand and predictable income.
  
• Retail or office spaces might carry higher cap rates to account for vacancy risk and tenant turnover.
  
• Industrial and self-storage assets often fall somewhere in the middle, with cap rates depending heavily on tenant mix and market trends.

2. Location and Submarket

Real estate is hyper-local, and cap rates reflect that. 

In core markets like New York City or San Francisco, investors often accept lower cap rates in exchange for long-term stability and lower perceived risk.

In contrast, emerging or tertiary markets may offer cap rates in the 7%–10% range. Still, those higher yields come with added risk, such as less liquidity, weaker tenant demand, or economic uncertainty.

Even within the same metro area, cap rates can differ based on submarket conditions, neighborhood trends, or zoning changes.

3. Tenant Credit and Lease Structure

Who’s paying the rent – and how secure is that income?

Cap rates are heavily influenced by the quality of the tenant and the structure of their lease. A long-term lease with a national credit tenant on a triple-net (NNN) basis might command a lower cap rate due to reduced risk and responsibility. Conversely, properties with short-term leases, local tenants, or high rollover risk tend to be priced with a higher cap rate to reflect potential instability.

Understanding the income stream (not just the amount, but the durability) is critical.

4. Property Condition and Operational Risk

Cap rates are typically based on current NOI, not projected income after renovations. That means properties with deferred maintenance, high vacancy, or management inefficiencies might show an attractive cap rate on paper, but carry operational risks that erode returns.

Investors should dig deeper into the property’s condition, CapEx requirements, and potential for income growth when interpreting the cap rate.

5. Market Conditions and Macroeconomic Trends

In a low-interest-rate environment, investors tend to chase yield, compressing cap rates across the board. When interest rates rise, cap rates often follow – especially in riskier asset classes. Supply and demand dynamics, inflation expectations, and investor sentiment all play a role.

6. Value-Add vs. Stabilized Assets

A common source of confusion is comparing cap rates on stabilized versus value-add properties.

A value-add deal might show a “pro forma” cap rate of 9%, but that number assumes you execute renovations, increase rents, and stabilize occupancy. Until then, the in-place cap rate may be far lower, and the investment carries execution risk.

Stabilized properties with predictable income will generally trade at lower cap rates, while value-add deals should offer higher returns to compensate for the effort and uncertainty involved.

7. Investor Risk Tolerance and Strategy

Finally, what qualifies as a “good” cap rate depends on the investor.

A core investor seeking passive income might be satisfied with a 5% cap rate in a high-demand urban market. A more aggressive investor focused on appreciation or repositioning may target 8%+ cap rates in developing areas.

There’s no universal “right” number, only the right number for your goals, strategy, and tolerance for risk.

Takeaway: Cap Rates Require Context

The next time you see a listing advertising a “12-cap” property, pause before getting too excited. Ask yourself: why is the return so high? What risks is the market pricing in? Is the income stable, or speculative?

Cap rates are a helpful starting point,  not a verdict. By understanding the variables that influence them, investors can make more informed decisions and avoid chasing deals that look good on paper but fall apart in practice.