KO Appraisal
Guide

What is a good cap rate?

This is the most-asked follow-up in commercial real estate, and most published answers to it are invented. A cap rate is not good or bad in isolation. It is the market’s price for a specific risk profile on a specific date. What can be said usefully is what makes a rate appropriate for a given property, and how to tell when one is out of line.

Why no honest source publishes a universal number

Any article stating that a good cap rate is a particular range is describing one property type, in one kind of market, at one moment, and then generalising it. Rates move with the cost of capital, and they differ across sectors and submarkets by more than the width of most published ranges.

An appraiser cannot publish a number and stand behind it, because the defensible rate for any given assignment comes from verified comparable transactions as of the effective date. A figure quoted from an article is not evidence. If a report cites a rate without showing the sales it came from, that is a gap in the report.

The question that is actually answerable

Reframe it as: is this rate appropriate for this property, given what the market is paying for comparable risk? That has an answer, and it is the question an appraisal exists to settle. It resolves into a comparison along the dimensions that drive pricing:

  • Is the income durable? Long leases to strong covenants support lower rates than short leases to unrated local tenants.
  • Is it likely to grow? Contractual escalations, below-market rents rolling to market, and supply-constrained submarkets all argue for a lower rate. The reverse argues for a higher one.
  • What does the owner actually have to spend? A property needing near-term capital expenditure carries risk that shows up either as a higher rate or an explicit deduction, and the appraisal must state which, or it gets counted twice.
  • How liquid is the asset? Property that few buyers can finance or operate trades at higher rates, because the buyer pool is the market.
  • What could the site otherwise be? Where redevelopment potential exists, buyers may pay past what current income justifies, and the resulting low rate reflects land value rather than the income stream. Capitalising income on such a property understates it. This is a highest and best use question, not a cap rate question.

When a rate should make you suspicious

A rate materially below the comparable set usually means the numerator was inflated, reserves omitted, a vacancy allowance ignored, or a one-off item treated as recurring income. A rate well above it usually signals something the headline number is not telling you: a lease about to expire, a tenant in difficulty, deferred maintenance, or a ground lease or other encumbrance limiting what the buyer actually acquires.

In both directions the correct response is the same. Go back to the income statement and verify what produced it. An outlier rate is a prompt to investigate, not a conclusion.

Common questions

What is a good cap rate for rental property?
It depends on the asset and the market, not on a universal benchmark. The meaningful test is whether the rate is consistent with verified sales of comparable properties in the same submarket as of the same date. A rate that looks attractive against a national article but sits well outside the local comparable set is telling you something about the property, and it is rarely good news.
Is a 7% cap rate good?
It is good or bad only relative to what comparable properties are trading at. In a submarket where similar assets transact at 5.5%, a 7% rate signals additional risk the price is compensating for, and the useful question becomes what that risk is. In a market where comparables trade at 8%, the same 7% represents a premium price.
What is a good cap rate for commercial property specifically?
Sectors price differently, and the ordering among them shifts with capital-market conditions, so a rate appropriate for a leased industrial building is not a benchmark for a multi-tenant retail centre or an older office asset. Comparability means the same sector, similar tenancy and lease term, similar submarket, and a similar date.
Does a low cap rate mean a property is overpriced?
Not necessarily. Low rates are what the market pays for durable, growing, low-risk income, and they are entirely rational for such assets. A low rate is a concern when it is not supported by the property’s characteristics, when the income is neither especially safe nor especially likely to grow, and the price simply assumes it is.
How much does the interest-rate environment move cap rates?
Materially, though not on a fixed one-for-one basis. Debt cost and availability change what buyers can pay, and rates generally move with them over time, but the relationship is loose and lagged, because property transactions are slow and sellers resist repricing. The practical consequence for valuation is that rates extracted from sales in a different rate environment need to be treated as dated evidence.
Who wrote this Kevin O'Brien, MAI, SRA. California Certified General Real Estate Appraiser #3005065, issued by the California Bureau of Real Estate Appraisers (BREA). Practicing in San Diego. This page reflects how these assignments are actually handled, not a summary of other people's summaries.
Where this applies Appraiser licensing is state-specific, there is no national appraisal licence, so appraisal engagements here are California properties, primarily San Diego County. The valuation methodology and the federal tax rules described above apply anywhere in the United States; if your property is in another state, you need an appraiser credentialed there, and this page should still tell you what to ask them for.

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