Quick answer. A cap rate, short for capitalization rate, is a property’s annual net operating income divided by its price. A building that produces $159,250 of net operating income and sells for $2,450,000 trades at a 6.50% cap rate. It measures first year yield with no mortgage in the picture. It is not a return, and it says nothing on its own about whether the income behind it will still be there in year seven.
The formula
There is only one equation, and it gets rearranged depending on what you already know.
| You want | Formula | When you use it |
|---|---|---|
| Cap rate | NOI ÷ Price | A property is offered at a price and you want the yield |
| Value | NOI ÷ Cap rate | You know the income and the going rate for that kind of asset |
| NOI | Price × Cap rate | Checking whether a quoted cap rate and a quoted price agree |
That third form is worth running on every offering memorandum you read. Brokers make arithmetic errors more often than you would expect, and the price, the cap rate and the stated NOI on the cover page do not always reconcile.
A worked example
Take a freestanding retail building on a corporate lease. Base rent is $166,600 a year. The landlord carries $7,350 of costs the tenant does not reimburse, mostly insurance deductible exposure and a small share of the shared parking maintenance. Net operating income is $159,250. The seller is asking $2,450,000.
$159,250 ÷ $2,450,000 = 0.065, or a 6.50% cap rate.
Now hold the income constant and change nothing about the building. If a buyer decides that asset should trade at 8.00% instead, the same $159,250 supports a price of $1,990,625. The rent did not change. The roof did not change. The value moved $459,375 because the market’s view of the risk moved 150 basis points. That sensitivity is the entire reason cap rates matter, and it is also why arguing about a tenth of a point in a letter of intent is rarely where the money is.
What belongs in net operating income, and what does not
Most bad cap rate math is bad NOI math. The denominator is a number you can verify with a purchase contract. The numerator is a construction, and reasonable people build it differently.
| Include | Exclude | Judgment call |
|---|---|---|
| Contractual base rent | Mortgage principal and interest | Vacancy and credit loss |
| Expense reimbursements actually collected | Depreciation and amortization | Management fee, even on a self-managed asset |
| Percentage rent earned in the trailing period | Capital expenditures and tenant improvements | Replacement reserve for roof, HVAC and parking |
| Recurring ancillary income such as billboard or cell site rent | Leasing commissions | Non reimbursed insurance in a hard market |
| Income taxes and one time items |
In practice, single tenant net lease deals are usually quoted on in place contractual rent with no management fee and no reserve deducted. That is the market convention and there is nothing dishonest about it, but it does mean a quoted 6.50% is a slightly generous version of what will actually land in your account. On a 25 year old building with an aging roof, subtract a real reserve before you compare two deals against each other.
What is a good cap rate right now
There is no single answer, which is an unsatisfying thing to say and also the truth. A 5.25% cap rate on a ground leased asset with 18 years of term and an A rated obligor can be a better piece of paper than an 8.25% cap rate on a franchisee lease with four years left. What you can do is anchor yourself to where the market actually cleared last quarter.
The Boulder Group’s second quarter 2026 net lease research put overall single tenant asking cap rates at 6.82%, two basis points higher than the prior quarter.
| Sector | Q2 2026 asking cap rate | Quarter over quarter |
|---|---|---|
| All single tenant net lease | 6.82% | Up 2 bps |
| Retail | 6.60% | Up 5 bps |
| Industrial | 7.25% | Up 10 bps |
| Office | 7.90% | Unchanged |
Asking cap rates, single tenant net lease, Q2 2026. Source: The Boulder Group quarterly net lease research.
The averages hide the part that matters. Supply on the market rose 12.5% during the quarter to roughly 5,800 properties, and retail listings alone jumped 16.2%. But assets combining an investment grade tenant with long remaining term made up less than 10% of that retail inventory. So the number of properties available went up while the number of properties most 1031 buyers will actually accept barely moved. That is why the good deals still trade tight while the average keeps drifting out.
How cap rates relate to interest rates
Cap rates are priced off the risk free rate plus a spread for everything a Treasury does not carry: illiquidity, credit risk, re-tenanting risk, and the cost of owning a physical building.
Through the first half of September 2026 the 10 year Treasury traded in a band roughly between 4.78% and 4.98%, its highest range since late 2023. Set that against retail net lease at 6.60% and the spread is somewhere near 165 to 180 basis points. Historically that gap has run closer to 250 or 300. Net lease pricing has not fully repriced to the current cost of capital, which is a polite way of saying sellers are still anchored to 2021 and buyers are not.
Two things follow. First, a property bought at a thin spread depends on rate relief to work, and the Federal Reserve removed the single 2026 cut it had been projecting. Second, spread compression of this kind usually resolves through time rather than through a crash, because most net lease owners have no forced seller pressure. We cover the mechanics in more detail on cap rates and interest rates.
Cap rate, cash on cash, and IRR
These get used interchangeably in conversation and they measure three different things.
| Metric | What it measures | Debt included | Time horizon |
|---|---|---|---|
| Cap rate | First year unleveraged yield | No | One year |
| Cash on cash | Cash distributed against cash invested | Yes | One year |
| IRR | Annualized return across the full hold, including sale | Optional | Whole hold period |
A 6.50% cap rate with 2% annual rent bumps and a 10 year hold behaves very differently from a 6.50% cap rate on flat rent, and the cap rate will not tell you that. The escalation schedule is usually worth more than the twenty five basis points people spend two weeks negotiating.
Five places a cap rate misleads you
1. The rent is above market. If the tenant is paying $28 a foot in a $19 a foot submarket, the cap rate is real today and fictional the day that lease expires. Check rent against comparable space before you check anything else.
2. The name on the building is not the name on the lease. A franchisee operating 11 units guarantees the rent, not the national brand. The brand sells the property, the guarantor pays for it. Our bond and credit rating reference is the starting point for telling the two apart.
3. Ground lease against fee simple. A ground lease cap rate and a fee simple cap rate are not comparable numbers. One buys the dirt under a building someone else owns and depreciates almost nothing. The other buys the building too.
4. Remaining term. See the $459,375 swing above. Term is the single largest driver of net lease pricing after credit, and a property with four years left is a re-tenanting project wearing an income statement.
5. Proforma NOI. If the income used in the cap rate includes a vacant suite leased at an assumed rent, you are being quoted a hope, not a yield. Ask for the rent roll and the trailing twelve.
How NNN and 1031 buyers should actually use it
Use the cap rate to sort, not to decide. It is a fast way to rank twenty offerings into a shortlist of four. After that it stops being useful and the underwriting questions take over: who signs the lease, what happens in year one after expiration, how the rent escalates, whether the site works for a second generation user, and what the debt market will do with it when you sell.
For 1031 buyers the constraint is worse, because the 45 day identification clock pushes people toward whatever is available rather than whatever is right. A cap rate that looks generous under deadline pressure is usually generous for a reason someone else already found.
- Current NNN cap rates by tenant credit quality
- 1031 exchange rules and replacement property strategy
- What a triple net lease actually covers
- Dollar General credit rating and cap rate profile
- Walgreens credit rating and cap rate profile
Frequently asked questions
How do you calculate a cap rate?
Divide annual net operating income by the purchase price. A property with $159,250 of net operating income priced at $2,450,000 has a 6.50% cap rate. Net operating income is rent and reimbursements less the operating costs the owner actually bears, before any mortgage payment.
What is a good cap rate?
It depends on what is producing the income. In the second quarter of 2026 single tenant net lease asking cap rates averaged 6.82% overall, with retail at 6.60%, industrial at 7.25% and office at 7.90%. Investment grade tenants on long leases trade below those averages. Non rated and franchisee backed leases trade above them.
Is a higher cap rate better?
A higher cap rate means more first year income per dollar spent, and it also means the market has priced more risk into that income. The useful question is whether the extra yield fairly compensates for weaker credit, shorter term, or a harder to re-lease building. Often it does not.
What is the difference between cap rate and ROI?
Cap rate is a single year unleveraged yield on the purchase price. Return on investment usually accounts for financing, appreciation and the eventual sale. Two properties can carry the same cap rate and produce very different returns depending on rent escalations, debt terms and exit pricing.
Do cap rates rise when interest rates rise?
Usually, though with a lag and not one for one. Cap rates are priced as a spread over the risk free rate. When Treasury yields rise faster than cap rates, that spread compresses, which is what has happened through 2026 with the 10 year trading near 4.8% to 5.0% against retail net lease near 6.60%.
What cap rate should a 1031 buyer expect in 2026?
Most credit tenant replacement properties are clearing somewhere between the mid 5% and high 6% range, with the tightest pricing on long term ground leases and investment grade obligors. Anything meaningfully above the sector average is carrying a specific risk, and identifying that risk before the 45 day deadline is the whole job.
Sources and method
Sector cap rate figures are from The Boulder Group’s quarterly single tenant net lease research for the second quarter of 2026. Treasury yields are daily constant maturity quotes for the first two weeks of September 2026. Cap rate ranges by tenant credit quality reflect our own review of closed and marketed single tenant transactions, and are maintained on our NNN cap rates page. This page is educational and is not investment, tax or legal advice.
