When I first started looking at commercial real estate deals, the cap rate number always popped up. Everyone talked about it like it was the golden rule , but no one really explained what made a “good” one. And the truth is, it’s not a fixed number. It depends on what you’re buying, your risk appetite, and how the property performs.
So if you’re trying to figure out whether a commercial property is priced right, or what kind of return you should expect, let’s make this simple. I’ll walk you through exactly what cap rate means, what numbers usually make sense, and how to judge if you’re looking at a solid investment.
What Is a Good Cap Rate for Commercial Property?
What Is a Cap Rate in Commercial Real Estate?
Let’s start with the basics, because if you don’t fully understand how a cap rate works, the rest of the numbers won’t mean much.
The cap rate, short for capitalization rate, is a formula used to estimate the return on a commercial property, based on the income it generates. You calculate it like this:
Cap Rate = Net Operating Income (NOI) ÷ Property Value
The result is a percentage, and that percentage tells you how much income the property generates compared to its cost.
So if a warehouse earns $100,000 in net operating income per year and it costs $1,400,000, the cap rate is:
100,000 ÷ 1,400,000 = 7.14%
That means you’re earning roughly 7.14% of the property’s value in annual net income, before mortgage payments or taxes. U.S. Government Accountability Office shows risks in CRE (credit, price declines especially for office), which help explain why cap rates are rising
My First Lesson in Cap Rates
When I bought my first small industrial unit, I didn’t think much about cap rates. I was focused on location, tenant, lease term , all good things , but I skipped over the math.
A buddy of mine who owns several strip centers looked at my deal and said, “Looks okay, but what’s the cap?” I had no clue. We ran the numbers together, and it came out to 4.9%. For that kind of property, in that kind of area, he told me it was way too low unless I had some long-term play in mind.
That deal taught me something: cap rates aren’t just formulas; they reflect risk, value, and opportunity. Ever since then, I’ve used cap rates as one of my key filters before even setting foot on a site.
Why Cap Rate Matters
In commercial real estate, everything revolves around income. The cap rate gives you a fast way to compare properties based on that income, no matter the size or type. It helps you:
- Compare deals across markets or property types
- Estimate fair purchase prices
- Decide if the return justifies the risk
- Spot underpriced or overpriced properties
The key is knowing what kind of cap rate makes sense for the specific property you’re looking at, and that’s what we’re getting into next.
Current Average Cap Rates by Property Type
Cap rates are not one-size-fits-all. The type of commercial property plays a huge role in what’s considered normal or profitable. Different assets come with different risks, tenant structures, and income predictability. That’s why industrial, office, and retail spaces often land in very different cap rate ranges.
Take industrial properties, for example. These have gained strong attention over the past few years thanks to e-commerce growth and stable long-term leases with logistics companies. Because of their relatively low management needs and consistent demand, cap rates for industrial properties are usually tighter. In strong markets, you might see cap rates from 6% to 7.5%, depending on the age of the facility and the lease profile.
Retail properties can vary more widely. A strip center anchored by solid national tenants will likely offer a lower cap rate, often in the 6% to 7% range, reflecting investor confidence in tenant stability. On the other hand, older retail centers with mom-and-pop tenants, or properties in weaker locations, can stretch into the 8% or 9% range, signaling higher risk, potential vacancies, or the need for redevelopment.
Then there’s office space, which has seen a lot of shift post-pandemic. Cap rates here are generally higher because vacancy rates have risen and demand patterns are still adjusting. In many markets, good quality office properties show cap rates around 6.5% to 8%, with older or less ideally located offices pushing even higher. Investors want a higher return to offset longer lease-up times and changing tenant behavior.
What’s Considered a ‘Good’ Cap Rate Right Now?
The definition of a “good” cap rate can feel frustratingly vague. That’s because it depends on the context, not just the asset class, but also how much risk you’re willing to accept. For example, if you’re looking at a Class A retail building in a well-trafficked area, a cap rate of 6% might be completely fair because of the stability. But if that same building had a major tenant rollover or needed renovations, you’d probably want a cap rate above 7% to make the deal worth the uncertainty.
In most cases, a good cap rate matches your investment goals. If your focus is long-term hold and stable income, a lower cap rate might still be attractive if it comes with strong tenants and minimal turnover. But if you’re aiming for value-add or shorter-term repositioning, you’ll want a higher cap rate that gives you room to boost income or sell at a profit later.
In the current market, with interest rates higher than they’ve been in years, cap rates have also adjusted upward. That means many properties that used to trade at 5.5% or 6% are now priced at 6.5% to 7.5%, offering better initial returns, but possibly reflecting slower appreciation or tougher financing.
There’s also a difference between asking cap rates and actual cap rates at closing. Brokers often list properties with optimistic assumptions, but after due diligence, buyers usually negotiate prices down, bringing the real cap rate back in line with market expectations.
Whether you’re looking at your first deal or your fiftieth, understanding the typical cap rate ranges by property type helps you judge what’s realistic. A 7% cap rate on a clean, leased industrial building might be a solid win. A 9% cap rate on an empty office building could be a warning sign or an opportunity, depending on your plan.
The smart investor doesn’t chase cap rates; they weigh them. It’s about matching the return to the risk, and making sure you’re not blinded by a high number or scared off by a low one without understanding the full picture.
How Location Impacts Cap Rate
Location is one of the biggest drivers of cap rate, and not just in terms of city or region. Even within the same metro area, cap rates can shift drastically depending on the neighborhood, access to infrastructure, and surrounding businesses. Here’s how it plays out:
Core vs. Secondary Markets
- Core markets (city centers or business districts) usually command lower cap rates. These areas have higher demand, stronger tenant pools, and lower vacancy rates.
- Secondary or fringe areas tend to carry higher cap rates. That’s because they’re less in demand, may have higher vacancy risks, and often take longer to lease or sell.
Proximity to Infrastructure
- Properties near major highways, ports, or airports usually perform better. Easy logistics = higher tenant demand = lower cap rate.
- Locations far from infrastructure or with limited access might see higher cap rates due to slower leasing and lower rental income potential.
Local Economy and Job Growth
- Markets with strong job growth and economic development tend to have tighter cap rates. Investors are willing to accept lower returns for higher long-term stability.
- In contrast, markets with weak job trends or declining population often see cap rate expansion, as investors require more return to accept the risk.
Example Cap Rate Differences by Location Type
Here’s a general snapshot of how location can affect commercial cap rates:
| Location Type | Typical Cap Rate Range |
| Prime urban core | 5.5% – 6.5% |
| Close-in suburban areas | 6% – 7.5% |
| Outer suburbs / rural | 7% – 9%+ |
Keep in mind, these aren’t fixed rules; they’re general trends. A strong tenant in a rural area might still justify a low cap rate, and a distressed property in a downtown core could demand a higher one.
The key takeaway is: never look at the cap rate in isolation. Always ask, “What kind of location is this, and how does that impact risk, income, and exit value?” Once you build that habit, you’ll start spotting better deals faster.
Property Condition and Age: How Much Does It Matter?
The physical condition of a commercial property, and how old it is, plays a bigger role in cap rate than many new investors realize. Even two buildings on the same street, serving the same purpose, can have wildly different cap rates just because of their age, maintenance history, or renovation status.
Newer Properties vs. Older Buildings
- Newer commercial buildings often come with lower cap rates. That’s because they typically require less immediate maintenance, meet current building codes, and attract higher-quality tenants.
- Older buildings, especially those over 20–30 years old, may demand higher cap rates to offset risks like outdated systems (HVAC, plumbing, roofing), higher insurance, or the cost of upgrades.
Renovated vs. Deferred Maintenance
- A building that’s recently renovated or well-maintained signals lower near-term costs for the new owner. Investors might accept a lower cap rate for that peace of mind.
- On the other hand, if there’s deferred maintenance , think roof leaks, uneven parking lots, or old wiring , buyers will want a higher cap rate to justify the work ahead.
Building Layout and Efficiency
- Some older buildings have layouts that no longer work for modern tenants. Narrow corridors, inefficient space use, or outdated lobbies can hurt leasing potential. That increases the risk of longer vacancies, which in turn pushes the cap rate higher.
- More functional and flexible layouts, even in older buildings, can help attract a wider range of tenants , which may help maintain or even lower cap rates.
Environmental and Code Compliance
- If the property is in an area with strict codes or has environmental issues (like asbestos, poor drainage, etc.) , cap rates usually increase. Investors know they’re facing added costs and liabilities, so they demand more return.
- Conversely, buildings that are fully code-compliant and “plug-and-play” ready for new tenants tend to trade tighter.
In short, the condition of the property is directly tied to the risk of unexpected expenses. Investors don’t just look at income; they look at the likelihood of repairs, upgrades, or tenant issues. That’s why a newer building in great shape might sell at a 6.5% cap, while a similar property with a 20-year-old roof sells at 8%. It’s all about how much uncertainty the buyer is willing to take on.
Lease Terms and Tenant Strength
When you look at a commercial property, it’s not just the walls and the roof that create value; it’s the lease and who’s paying it. Strong tenants and solid lease structures can make a massive difference in what cap rate is considered acceptable. In fact, many experienced investors look at the lease before they even look at the building.
Long-term leases with creditworthy tenants bring more stability. If a property is leased for the next 10 years to a national brand or large corporation, the income stream is reliable. That reduces perceived risk, and investors are willing to accept a lower cap rate. A tenant like that isn’t going to default or vacate without notice. There’s predictability, and that’s worth money.
On the other hand, short-term leases or tenants with unknown financials bring a lot more uncertainty. If a lease is set to expire in 12 months and the tenant isn’t locked in, that’s a red flag. The new owner may face vacancy, renegotiation, or even build-out costs if the space has to be re-leased. In this case, buyers will typically want a higher cap rate to compensate for that instability.
The type of lease also plays a role. Triple net leases (NNN), where the tenant pays taxes, insurance, and maintenance, are especially attractive because the owner has minimal operating responsibility. These kinds of leases generally result in lower cap rates, since the cash flow is clean and consistent. Gross leases, where the landlord covers many expenses, can lead to more financial surprises and tend to push cap rates upward.
Tenant diversity is another key factor. A property with one single tenant may be fully leased , but if that tenant leaves, income drops to zero. In contrast, a multi-tenant building might have a few vacancies, but the income is more diversified. So while single-tenant properties with strong tenants may get lower cap rates, multi-tenant setups can offer more risk-adjusted balance if properly managed.
At the end of the day, cap rates reflect risk , and leases tell you where that risk sits. A building with short leases and mom-and-pop tenants is a very different animal than one leased to a Fortune 500 company under a 10-year NNN agreement. That’s why serious investors always ask, “Who’s on the lease, and how long are they staying?” before asking about anything else.
Market Trends Affecting Commercial Returns
Cap rates don’t exist in a vacuum; they move with the market. The overall direction of the economy, interest rates, lending standards, and demand for space all shape what investors are willing to accept in return for their money. When market trends shift, so does the definition of a “good” cap rate.
One of the biggest influences is the interest rate environment. When borrowing becomes more expensive, cap rates tend to rise. That’s because investors demand higher returns to offset the cost of capital. In a low-rate world, a 5.5% cap might look attractive. But if interest rates jump, that same deal might not pencil out, and investors start demanding 6.5% or more to justify the risk.
Supply and demand also play a role. If there’s a lot of new construction flooding the market, landlords may face more vacancy or downward pressure on rent, which can push cap rates higher. Conversely, if there’s limited inventory and strong tenant demand, prices rise, income holds steady, and cap rates compress.
The performance of specific property types shifts with broader economic forces. For example, during the boom in e-commerce, industrial properties became hot, and cap rates tightened. Office space, affected by remote work trends, saw cap rates climb due to increased vacancies and uncertainty. Retail has been a mixed bag, with well-located centers doing well, and others struggling against changing consumer habits.
Another trend is the tightening of financing standards. When lenders become more conservative, it gets harder to close deals. That limits buyer competition, which in turn impacts pricing and cap rates. Properties with clear, stable income streams become more valuable in that kind of environment.
Smart investors don’t just look at the property; they look at what the market is doing and where it’s headed. If the trends point toward growth and stability, cap rates may hold or fall. But if there’s volatility or tightening conditions, cap rates will rise, and you’ll need to underwrite more conservatively.
How to Use Cap Rate When Evaluating a Commercial Property Deal
Cap rate isn’t the only metric you should look at, but it’s a powerful starting point. When I analyze a deal, the cap rate gives me a fast way to compare it to others. If it’s too low for the asset class or market, I ask why. Is the tenant unusually strong? Is there hidden value or redevelopment potential?
Cap rate also helps you gauge whether a property is fairly priced. If the NOI is $120,000 and the asking price is $2 million, that’s a 6% cap. Depending on what other similar deals are trading at, that may be a steal, or it could be overpriced. Cap rate lets you test the logic of the numbers.
It’s also helpful in reverse. If you want to hit a certain return, you can work backward. For example, if you’re targeting an 8% cap, and the NOI is $160,000, then the most you should pay is $2 million. Any higher, and you’re not hitting your goal.
Cap rate also helps in conversations with brokers and sellers. If someone tells me their deal is “a solid 7,” I can immediately do the math and see if their NOI numbers support that, or if they’re playing with projections.
It’s not a magic number, but a cap rate can keep you from making motivational decisions. It gives you structure. And once you get comfortable reading it alongside other numbers like cash-on-cash return, IRR, and debt coverage, you’ll start making sharper investment calls.
What to Watch Out For: Cap Rate Traps in Commercial Deals
Sometimes a high cap rate looks like a win , but it’s really a warning sign. If you see a property listed with an 8.5% or 9% cap in a market where most assets trade at 6% to 7%, ask yourself: What’s wrong here?
It could be high vacancy, a weak or short-term tenant, deferred maintenance, or even overestimated income. I’ve walked properties that looked amazing on paper, until I saw the rent roll or noticed half the HVAC units were 20 years old. Those hidden risks are exactly why cap rates are just the start of the story.
You should also be cautious of “pro forma” cap rates. These are based on future projected income, not actual income today. Some sellers inflate numbers by assuming rent increases or full occupancy, but if that hasn’t happened yet, it’s not real. Always ask for the trailing twelve months (TTM) of actual income and expenses before trusting the cap rate.
Another trap is ignoring the cost of capital improvements. A property might have a 7.5% cap, but if you need to spend $300,000 on a new roof, that eats into your return quickly. Smart investors factor in both the current income and the likely expenses coming up.
The safest cap rate is one that reflects today’s reality, not future hopes, not aggressive assumptions, and not overly polished broker packages. Run the math, ask the hard questions, and look beneath the surface. That’s how you avoid cap rate traps and find deals that actually work.
Final Thoughts
Cap rate is one of the most useful tools in commercial real estate , but only if you know how to read it in context. It gives you a snapshot of potential return, but the real value lies in asking why the cap rate is what it is.
Look beyond the number. Check the tenant, lease, condition, and market trends. When you balance the return with the risk, you’ll start making smarter, more confident investment decisions every time.
Ready to Evaluate Commercial Deals with Confidence?
If you’re looking to buy, sell, or analyze commercial real estate and want expert insight tailored to your goals, connect with someone who knows the numbers and the Louisville market.
Visit raphaelcollazo.com to get trusted help from a local pro who understands cap rates, market trends, and what makes a deal truly worth it. Whether you’re new to investing or scaling up, Raphael can guide you every step of the way.
