# What Is Capitalisation Rate? Cap Rate Formula Guide Published: 2026-04-19 Author: Warren Team URL: https://www.heywarren.com/blog/cap-rate-real-estate --- You walk into a commercial real estate deal and the broker pitches you a "7 cap." Your friend brags about buying multifamily at a "5 cap." A REIT report mentions "cap rate compression." Everyone throws around the term, but [what is capitalisation](/blog/what-is-capitalisation) rate, actually, and why does this single number drive trillions of dollars in property valuation? The cap rate is the most important metric in commercial real estate. Misunderstand it, and you'll overpay for an asset, mis-price a sale, or compare deals that aren't comparable. Get it right, and you can quickly screen properties, value buildings on the back of a napkin, and identify market dislocations worth millions. This guide breaks down the cap rate formula, walks through worked examples, shows you typical cap rates by property type, and explains the critical relationship between cap rates and interest rates that's reshaping CRE valuations in 2024-2025. By the end, you'll think like an institutional investor, and avoid the most common mistakes that trip up first-time buyers. At Warren, we help investors translate Wall Street-grade frameworks into clear, actionable decisions. ## What Is Capitalisation Rate? The Definition The capitalisation rate (cap rate) is the ratio of a property's annual [Net Operating Income](/blog/calculation-of-net-operating-income) to its market value, expressed as a percentage. It represents the unlevered annual yield an investor would earn if they bought the property in cash, before financing, taxes, or appreciation. Think of cap rate as the "interest rate" the building pays you. An 8% cap rate means you're earning 8% of the purchase price per year in [operating income](/blog/formula-for-operating-income). It's the closest thing CRE has to a bond yield, a single, comparable number that lets you stack one office tower against another, or against a Treasury bond. Crucially, cap rate is unlevered. It ignores how you finance the deal. Two investors buying the same building at the same price get the same cap rate, even if one pays cash and the other uses 70% leverage. That makes cap rate useful for comparing the property itself, separate from the capital stack. ## The Cap Rate Formula The formula is elegantly simple, and it works in two directions depending on what you're solving for. **Cap Rate = Net Operating Income / Property Value** Or, rearranged to value a property: **Property Value = Net Operating Income / Cap Rate** ![Cap rate formula with worked example](data:image/svg+xml;base64,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) **Worked example:** A small office building generates $80,000 in annual NOI. It sells for $1,000,000. The cap rate is $80,000 / $1,000,000 = 8.0%. If a comparable building down the street has $120,000 NOI and the market cap rate is 8%, you'd value it at $120,000 / 0.08 = $1,500,000. Cap rates and prices move inversely. A "lower" cap rate sounds bad but actually means the market is paying a premium for that income, typical of trophy assets in gateway cities. A "higher" cap rate signals either better yield or higher perceived risk. ## What Goes Into NOI? Net Operating Income is the engine of the cap rate calculation. Get NOI wrong, and your cap rate is meaningless. NOI is gross revenue minus vacancy and operating expenses, but it deliberately excludes financing, depreciation, and capital expenditures. ![How gross rental income flows through vacancy and operating expense deductions to arrive at Net Operating Income, the numerator in the cap rate formula.](data:image/svg+xml,%3Csvg%20xmlns%3D%22http%3A%2F%2Fwww.w3.org%2F2000%2Fsvg%22%20viewBox%3D%220%200%20875%20125%22%20width%3D%22875%22%20height%3D%22125%22%20role%3D%22img%22%3E%3Ctitle%3EFlow%20diagram%3C%2Ftitle%3E%3Crect%20width%3D%22100%25%22%20height%3D%22100%25%22%20fill%3D%22%23f8fafc%22%2F%3E%3Crect%20x%3D%2230%22%20y%3D%2225%22%20width%3D%22170%22%20height%3D%2275%22%20rx%3D%2210%22%20fill%3D%22white%22%20stroke%3D%22%232563eb%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22115%22%20y%3D%2258.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3EGross%20Rent%3C%2Ftext%3E%3Ctext%20x%3D%22115%22%20y%3D%2278.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3E100%25%20occupancy%3C%2Ftext%3E%3Cline%20x1%3D%22205%22%20y1%3D%2262.5%22%20x2%3D%22237%22%20y2%3D%2262.5%22%20stroke%3D%22%2364748b%22%20stroke-width%3D%222%22%2F%3E%3Cpolygon%20points%3D%22244%2C62.5%20235%2C57.5%20235%2C67.5%22%20fill%3D%22%2364748b%22%2F%3E%3Crect%20x%3D%22245%22%20y%3D%2225%22%20width%3D%22170%22%20height%3D%2275%22%20rx%3D%2210%22%20fill%3D%22white%22%20stroke%3D%22%232563eb%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22330%22%20y%3D%2258.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3ELess%20Vacancy%3C%2Ftext%3E%3Ctext%20x%3D%22330%22%20y%3D%2278.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3E5%E2%80%9310%25%3C%2Ftext%3E%3Cline%20x1%3D%22420%22%20y1%3D%2262.5%22%20x2%3D%22452%22%20y2%3D%2262.5%22%20stroke%3D%22%2364748b%22%20stroke-width%3D%222%22%2F%3E%3Cpolygon%20points%3D%22459%2C62.5%20450%2C57.5%20450%2C67.5%22%20fill%3D%22%2364748b%22%2F%3E%3Crect%20x%3D%22460%22%20y%3D%2225%22%20width%3D%22170%22%20height%3D%2275%22%20rx%3D%2210%22%20fill%3D%22white%22%20stroke%3D%22%232563eb%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22545%22%20y%3D%2258.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3ELess%20OpEx%3C%2Ftext%3E%3Ctext%20x%3D%22545%22%20y%3D%2278.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3Etaxes%2C%20mgmt%2C%20repairs%3C%2Ftext%3E%3Cline%20x1%3D%22635%22%20y1%3D%2262.5%22%20x2%3D%22667%22%20y2%3D%2262.5%22%20stroke%3D%22%2364748b%22%20stroke-width%3D%222%22%2F%3E%3Cpolygon%20points%3D%22674%2C62.5%20665%2C57.5%20665%2C67.5%22%20fill%3D%22%2364748b%22%2F%3E%3Crect%20x%3D%22675%22%20y%3D%2225%22%20width%3D%22170%22%20height%3D%2275%22%20rx%3D%2210%22%20fill%3D%22white%22%20stroke%3D%22%232563eb%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22760%22%20y%3D%2258.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3ENOI%3C%2Ftext%3E%3Ctext%20x%3D%22760%22%20y%3D%2278.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3E%C3%B7%20Value%20%3D%20Cap%20Rate%3C%2Ftext%3E%3C%2Fsvg%3E) *How gross rental income flows through vacancy and operating expense deductions to arrive at Net Operating Income, the numerator in the cap rate formula.* The standard buildup looks like this: - **Gross Potential Rental Income** (every unit at market rent, fully occupied) - **Less: Vacancy and Credit Loss** (typically 5-10%) - **Plus: Other Income** (parking, laundry, storage, billboards) - **= Effective Gross Income** - **Less: Operating Expenses**, property taxes, insurance, property management fees (3-5% of EGI), utilities, repairs and maintenance, landscaping, trash, payroll - **= Net Operating Income (NOI)** What NOI explicitly excludes: mortgage interest and principal (debt service), depreciation (a non-cash accounting item), income taxes, and capital expenditures like roof replacements or HVAC upgrades. This exclusion is intentional, it isolates the property's operating performance from the buyer's specific financing and tax situation. This is also why investors use additional metrics beyond cap rate. Cash-on-cash return adds in your specific debt structure. IRR adds appreciation and the time value of money. But cap rate stays clean and comparable. ## Cap Rates by Property Type Cap rates vary dramatically across asset classes. Trophy assets in gateway markets trade at the lowest cap rates because investors view them as bond-like, stable cash flows, deep liquidity, and inflation hedging. Riskier or operationally intensive properties demand higher yields. ![Property types mapped by income stability and cap rate level, lower cap rates reflect higher perceived safety and liquidity.](data:image/svg+xml,%3Csvg%20xmlns%3D%22http%3A%2F%2Fwww.w3.org%2F2000%2Fsvg%22%20viewBox%3D%220%200%20720%20480%22%20width%3D%22720%22%20height%3D%22480%22%20role%3D%22img%22%3E%3Ctitle%3EQuadrant%20matrix%3C%2Ftitle%3E%3Crect%20width%3D%22100%25%22%20height%3D%22100%25%22%20fill%3D%22%23f8fafc%22%2F%3E%3Crect%20x%3D%2290%22%20y%3D%2225%22%20width%3D%22300%22%20height%3D%22190%22%20fill%3D%22%23dbeafe%22%2F%3E%3Crect%20x%3D%22390%22%20y%3D%2225%22%20width%3D%22300%22%20height%3D%22190%22%20fill%3D%22%23d1fae5%22%2F%3E%3Crect%20x%3D%2290%22%20y%3D%22215%22%20width%3D%22300%22%20height%3D%22190%22%20fill%3D%22%23ffedd5%22%2F%3E%3Crect%20x%3D%22390%22%20y%3D%22215%22%20width%3D%22300%22%20height%3D%22190%22%20fill%3D%22%23ede9fe%22%2F%3E%3Cline%20x1%3D%2290%22%20y1%3D%22215%22%20x2%3D%22690%22%20y2%3D%22215%22%20stroke%3D%22%2364748b%22%20stroke-width%3D%222%22%2F%3E%3Cline%20x1%3D%22390%22%20y1%3D%2225%22%20x2%3D%22390%22%20y2%3D%22405%22%20stroke%3D%22%2364748b%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22240%22%20y%3D%22100%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2213%22%20font-weight%3D%22700%22%20fill%3D%22%230f172a%22%3ECore%20Assets%3C%2Ftext%3E%3Ctext%20x%3D%22240%22%20y%3D%22120%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E%E2%80%A2%20Trophy%20Office%3C%2Ftext%3E%3Ctext%20x%3D%22240%22%20y%3D%22136%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E%E2%80%A2%20Multifamily%3C%2Ftext%3E%3Ctext%20x%3D%22540%22%20y%3D%22100%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2213%22%20font-weight%3D%22700%22%20fill%3D%22%230f172a%22%3EValue-Add%3C%2Ftext%3E%3Ctext%20x%3D%22540%22%20y%3D%22120%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E%E2%80%A2%20Industrial%3C%2Ftext%3E%3Ctext%20x%3D%22540%22%20y%3D%22136%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E%E2%80%A2%20NNN%20Retail%3C%2Ftext%3E%3Ctext%20x%3D%22240%22%20y%3D%22298%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2213%22%20font-weight%3D%22700%22%20fill%3D%22%230f172a%22%3EAvoid%20Zone%3C%2Ftext%3E%3Ctext%20x%3D%22240%22%20y%3D%22318%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E%E2%80%A2%20Distressed%20Office%3C%2Ftext%3E%3Ctext%20x%3D%22540%22%20y%3D%22290%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2213%22%20font-weight%3D%22700%22%20fill%3D%22%230f172a%22%3EOpportunistic%3C%2Ftext%3E%3Ctext%20x%3D%22540%22%20y%3D%22310%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E%E2%80%A2%20Hotels%3C%2Ftext%3E%3Ctext%20x%3D%22540%22%20y%3D%22326%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E%E2%80%A2%20Secondary%20Retail%3C%2Ftext%3E%3Ctext%20x%3D%2290%22%20y%3D%22425%22%20text-anchor%3D%22start%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3ELow%20Cap%20Rate%3C%2Ftext%3E%3Ctext%20x%3D%22690%22%20y%3D%22425%22%20text-anchor%3D%22end%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3EHigh%20Cap%20Rate%3C%2Ftext%3E%3Ctext%20x%3D%22390%22%20y%3D%22453%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2212%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3ECap%20Rate%3C%2Ftext%3E%3Ctext%20x%3D%2280%22%20y%3D%2237%22%20text-anchor%3D%22end%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3EHigh%20Stability%3C%2Ftext%3E%3Ctext%20x%3D%2280%22%20y%3D%22405%22%20text-anchor%3D%22end%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3ELow%20Stability%3C%2Ftext%3E%3Ctext%20x%3D%2235%22%20y%3D%22215%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2212%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%20transform%3D%22rotate%28-90%2035%20215%29%22%3EIncome%20Stability%3C%2Ftext%3E%3C%2Fsvg%3E) *Property types mapped by income stability and cap rate level, lower cap rates reflect higher perceived safety and liquidity.* ![Cap rate ranges by property type, US 2024-25](data:image/svg+xml;base64,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) - **Trophy office** (Manhattan, San Francisco Class A): 4-5% - **Multifamily / apartments**: 4.5-6% - **Industrial / logistics**: 5-7% (compressed during the e-commerce boom) - **Suburban office**: 7-10% (post-COVID stress, work-from-home) - **Hotels**: 7-10% (operationally intensive, cyclical) - **Secondary / tertiary retail**: 8-12% Geographic variation also matters. Gateway markets, NYC, San Francisco, LA, Boston, DC, consistently trade at lower cap rates than secondary cities like Cleveland or Memphis. Investors pay a "safety and liquidity premium" for global cities with deep buyer pools. A multifamily building at a 4.5 cap in Manhattan and a 7 cap in Indianapolis can both be fairly priced for their respective markets. ## Cap Rate vs Interest Rate: The Critical Spread Cap rates don't exist in a vacuum. They're priced relative to the risk-free rate, typically the 10-year US Treasury yield. The "spread" between cap rates and Treasuries reflects the extra return investors demand for taking on real estate risk: vacancy, illiquidity, management headaches, and capital intensity. ![Cap rate vs 10-year Treasury historical spread](data:image/svg+xml;base64,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) Historically, cap rates trade 200-500 [basis points](/blog/basis-points) (2-5%) over the 10-year Treasury. When rates rise, cap rates *should* rise too, meaning property values fall. That's exactly what happened in 2022-2024 as the Fed hiked aggressively. In 2022-2024, the market briefly saw a "cap rate-Treasury inversion" in some sectors: cap rates traded *below* Treasury yields. A trophy office at a 4% cap when 10-year Treasuries yielded 4.5% was theoretically a worse risk-adjusted bet than a risk-free bond. This signaled either irrational pricing, expectations of strong NOI growth, or sellers refusing to mark down assets, the classic "extend and pretend." Cap rates have since adjusted upward, repricing values lower. ## Worked Valuation Example Cap rates are the workhorse of CRE underwriting. Brokers, lenders, and appraisers all use them to triangulate value. Here's how the math plays out on a real-world deal. ![A 100 basis point rise in cap rate on the same $1.5M NOI cuts property value by $3.6M, illustrating how sensitive valuations are to cap rate shifts.](data:image/svg+xml,%3Csvg%20xmlns%3D%22http%3A%2F%2Fwww.w3.org%2F2000%2Fsvg%22%20viewBox%3D%220%200%20800%20210%22%20width%3D%22800%22%20height%3D%22210%22%20role%3D%22img%22%3E%3Ctitle%3EComparison%3C%2Ftitle%3E%3Crect%20width%3D%22100%25%22%20height%3D%22100%25%22%20fill%3D%22%23f8fafc%22%2F%3E%3Ctext%20x%3D%22230%22%20y%3D%2257.5%22%20text-anchor%3D%22end%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3E6%25%20Cap%20Rate%3C%2Ftext%3E%3Crect%20x%3D%22240%22%20y%3D%2225%22%20width%3D%22450%22%20height%3D%2255%22%20rx%3D%226%22%20fill%3D%22%232563eb%22%2F%3E%3Ctext%20x%3D%22702%22%20y%3D%2257.5%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22700%22%20fill%3D%22%232563eb%22%3E%2425M%3C%2Ftext%3E%3Ctext%20x%3D%22230%22%20y%3D%22152.5%22%20text-anchor%3D%22end%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3E7%25%20Cap%20Rate%3C%2Ftext%3E%3Crect%20x%3D%22240%22%20y%3D%22120%22%20width%3D%22385.714278%22%20height%3D%2255%22%20rx%3D%226%22%20fill%3D%22%237c3aed%22%2F%3E%3Ctext%20x%3D%22637.7142779999999%22%20y%3D%22152.5%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22700%22%20fill%3D%22%237c3aed%22%3E%2421M%3C%2Ftext%3E%3C%2Fsvg%3E) *A 100 basis point rise in cap rate on the same $1.5M NOI cuts property value by $3.6M, illustrating how sensitive valuations are to cap rate shifts.* Imagine a 50-unit apartment complex in Austin generating $1.5M in annual NOI after vacancy and operating expenses. Comparable Class B multifamily in submarket trades at a 6% cap rate. **Implied value: $1,500,000 / 0.06 = $25,000,000** Now suppose interest rates spike and cap rates expand to 7%: **New value: $1,500,000 / 0.07 = $21,428,571** That's a $3.6 million haircut, a 14% drop in value, from a 100 basis point cap rate move, with zero change in the building's operations. This is why CRE investors obsess over cap rate trends. A small move in the discount rate produces a massive swing in valuation. This connects to the **Gordon Growth analog**: Value = NOI / (Cap Rate − Growth Rate). If you expect NOI to grow 2% per year, a 6% cap rate effectively becomes a 4% cap rate adjusted for growth, and the property is worth more. This is why high-growth markets like Austin or Nashville command lower cap rates than slow-growth metros. ## Going-In Cap Rate vs Exit Cap Rate When underwriting a deal, sophisticated investors model two cap rates. The going-in cap rate is what you pay today (NOI / purchase price). The exit cap rate is what you assume the building will sell for at the end of your hold period, and it dramatically impacts your projected IRR. A common rule of thumb: assume the exit cap rate is 50-100 basis points *higher* than the going-in cap rate. Why? Buildings age, markets evolve, and conservative underwriting bakes in risk. If you buy at a 6 cap and sell at a 7 cap five years later, you need NOI growth just to break even on price. Cap rate compression cycles (cap rates falling, prices rising) reward early buyers. Cap rate decompression (cap rates rising, prices falling) punishes late buyers. The 2010-2021 era was a sustained compression cycle. 2022-2024 marked the start of decompression. Where we go from here depends largely on the Fed. ## Limitations of Cap Rate Cap rate is powerful but blunt. It captures a single-year snapshot of unlevered yield, and it ignores several factors that determine actual returns. Sophisticated investors layer additional metrics on top. Key limitations: - **No appreciation:** Cap rate ignores future value growth. A trophy asset at a 4 cap may outperform a 9 cap secondary retail property over 10 years if appreciation differs. - **No leverage:** Cap rate is unlevered. With 70% LTV financing at 6% interest, an 8 cap deal could produce a 12%+ cash-on-cash return. - **Static snapshot:** Cap rate uses Year 1 NOI. If you signed below-market leases, NOI will grow as they roll. - **No capex:** Cap rate uses NOI, but real cash flow needs capital expenditures (roof, HVAC, parking lots) subtracted. - **No lease term adjustment:** A property with a 20-year credit tenant lease deserves a much lower cap rate than one with month-to-month tenants, but the headline cap rate doesn't show this. For development projects, investors instead use **yield-on-cost**: stabilized NOI divided by total project cost (land + construction + soft costs). The spread between yield-on-cost and market cap rate is the developer's [profit margin](/blog/how-do-i-calculate-profit-margin), typically 100-200 bps to justify the construction risk. ## Common Mistakes to Avoid Even seasoned investors make cap rate errors. The most expensive ones come from sloppy NOI calculations or apples-to-oranges comparisons. Watch out for: - **Using gross income instead of NOI**, inflates the apparent yield by ignoring expenses - **Forgetting capex reserves**, NOI may say 8% but real cash flow is 6% after capital reserves - **Comparing across property types**, a 6 cap multifamily and a 6 cap hotel are not equivalent investments - **Ignoring lease quality**, long-term investment-grade tenants justify lower cap rates - **Trusting the seller's pro forma NOI**, always underwrite to actuals, not promises - **Overlooking the cap rate-rate relationship**, buying at peak compression right before rates rise is how investors get crushed The bottom line: cap rate is a starting point, not the answer. Use it to screen deals, anchor valuations, and benchmark against comps. Then layer in leverage, growth, exit assumptions, and lease analysis to build a complete underwriting picture. Compare cap rates within the same market and property type, never across categories without adjustment. Ready to put this knowledge to work? Try Warren, your AI financial advisor, get personalized, conflict-free guidance at heywarren.com --- ## Related Reading **More from Warren**: **Authoritative sources**: - [SEC Investor.gov, Investing Basics](https://www.investor.gov/introduction-investing/investing-basics) - [FINRA, Investor Education](https://www.finra.org/investors) ## Authoritative Sources For deeper background and primary-source data on this topic, the following authoritative sources are useful starting points: - [IRS](https://www.irs.gov/) - [SEC](https://www.sec.gov/) - [Federal Reserve](https://www.federalreserve.gov/) - [Consumer Financial Protection Bureau](https://www.consumerfinance.gov/)