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Commercial Real Estate Primer

Cap Rate by CRE Asset Class

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Cap Rate by CRE Asset Class

Cap rate—capitalization rate—is the annual net operating income divided by purchase price. It's the direct-yield lens through which institutional investors evaluate every commercial property.

Key takeaways​

  • Multifamily (apartments) trades at 4–5% cap rates in major markets, reflecting strong renter demand and lower volatility.
  • Retail has moved to 6–8% cap rates post-pandemic, pricing in brick-and-mortar headwinds and tenant disruption.
  • Hospitality (hotels) peaks at 8–10% cap rates, rewarding investors for income volatility and operational intensity.
  • Industrial and office occupy the middle band but face directionally different pressures.
  • Cap rates compress in hot markets and expand in recessions—they're a forward-looking barometer of risk appetite.

What cap rate really means​

Cap rate equals net operating income (NOI) divided by property price. If a multifamily property generates $2 million in annual NOI and sells for $50 million, the cap rate is 4%. It's the unlevered yield—the cash return before any debt service, refinance, or appreciation.

Unlike stock yields, cap rates aren't standardized. Two identical apartment buildings can trade at 4.5% in Manhattan and 5.5% in Houston. The gap reflects market expectations: supply/demand, population growth, financing costs, regulatory risk, and investor sentiment. In 2020–2022, cap rates compressed (prices rose faster than NOI) as low interest rates flooded capital into real estate. Since 2023, rate hikes have pushed cap rates back out, resetting valuations downward.

Cap rates also don't include leverage. A 4% cap rate property might return 15% to an equity holder who finances it at 60% loan-to-value with 5% borrowing costs. That spread—cap rate minus financing cost—is the engine of real estate returns. When that spread tightens, leverage becomes less attractive.

The multifamily band: 4–5% in tier-one metros​

Apartments are the darling of institutional capital. Class A multifamily in New York, Los Angeles, San Francisco, Boston, and Washington DC trades at 3.5–4.5% cap rates. Secondary markets (Austin, Denver, Tampa) occupy the 4.5–5.5% band. The low cap rates reflect:

  • Stable, recurring tenant revenue
  • Favorable demographic tailwinds (household formation, migration to cities)
  • Refinance optionality—apartment lenders are the most available
  • Shorter lease terms (1 year) so rents adjust faster to inflation
  • Low vacancy rates (typically under 5%)

During the 2008 recession, multifamily cap rates spiked to 7–8%, and investors who bought held exceptional long-term gains as cap rates compressed back to 5% by 2015. The asset class is cyclical but less volatile than office or hospitality. A 4% multifamily cap rate is a real yield, not a speculation bet.

Retail: 6–8% and rising​

Retail property includes neighborhood shopping centers, strip centers, power centers (anchored by big-box tenants), and malls. Pre-2020, retail traded at 5–6% cap rates. Then e-commerce accelerated, anchor tenants (Sears, JCPenney) collapsed, and the cap rate band exploded to 6–8% in most secondary and tertiary markets.

Power centers (anchored by Home Depot, TJ Maxx, Costco) hold the low end, around 6–6.5%. These retailers drive consistent foot traffic and maintain pricing power. Neighborhood centers with grocery and pharmacy anchor at 6–7%. Traditional strip centers without strong anchors: 7–8%. Dead malls: no market at any cap rate.

Retail pricing reflects real structural uncertainty. A landlord buying a 6.5% retail property in 2024 is being compensated for:

  • Tenant bankruptcy risk (especially mid-tier apparel)
  • E-commerce cannibalization of sales
  • Operating leverage to interest rates (high debt dependency)
  • Potential for rapid tenant turnover

Retail still works—Costco anchors rarely fail—but it requires operational acumen and strong anchors. A REIT like Realty Income (O) focuses on best-in-class retail and distributes that 3% yield with defensive characteristics.

Hospitality: 8–10% for illiquidity and volatility​

Hotels are pure operational assets. Revenue per room varies daily by occupancy and rate-per-room. A hotel at 60% occupancy with $150 average daily rate (ADR) has different cash flow than the same property at 75% ADR. Cap rates compensate for that chaos.

Full-service hotels (with restaurants, conventions) trade at 7–8% cap rates. Limited-service (extended stay, select-service) sit at 8–9%. Budget hotels and motels: 9–10%. The gap is structural: higher revenue per room but also higher operating expenses (labor, food, utilities) and more volatile tenure.

A hotel purchased in 2022 at an 8% cap rate with $120 ADR implied strong recovery from pandemic lows. By 2023–2024, as ADR normalized to $135–$145, those same properties would have traded at 7–7.5% cap rates. Hospitality is cyclical and leveraged; a 1–2% drop in occupancy or ADR can halve equity returns.

Industrial: The middle of the curve​

Warehouse and logistics properties occupy the 5–6.5% band. Class A, newly built, near major distribution hubs (Chicago, Dallas, Atlanta) trade at 5–5.5%. Older, secondary-market warehouse: 6–6.5%. The asset class benefits from structural tailwinds (e-commerce, supply chain reshoring) but faces cap rate pressure from Amazon and other corporate occupiers who can self-fund builds. A 5.5% warehouse cap rate is a reasonable inflation-hedge bet with 10-year single-tenant leases.

Office: Stretched and distressed​

Before 2020, Class A office in downtown metros traded at 4–5%. Post-pandemic and the work-from-home shift, office cap rates have exploded to 6–8% in major cities, and 8–10% in secondary markets. Office-to-residential conversions are happening in some cities (New York, San Francisco), creating distressed pricing. Class A trophy office (Apple Park neighbors, Manhattan's most modern buildings) still sees 5–6% cap rates; everything else is challenged.

Visualizing cap rate hierarchy​

Cap rate and market cycle​

Cap rates are not static. They expand and contract with credit conditions, interest rates, and investor appetite. In 2021, overleveraged buyers chased cap rates down to 3–3.5% on trophy multifamily, confident in rate suppression. By 2023, Fed funds at 5.5% and mortgage rates at 7–8% forced cap rates back to 4.5–5.5%. Properties that were "core-plus" in 2021 became "value-add" in 2023.

The relationship between cap rate and 10-year Treasury is loose but directional. When 10-year Treasuries yield 4%, a 4.5% cap rate property is a thin spread. When Treasuries yield 2%, a 4.5% cap rate is attractive. A 400–500 basis point spread between cap rate and Treasury yield is historically neutral; 300–400 bp suggests overheating; 600+ bp suggests distress.

Savvy investors watch cap rate expansion (prices falling faster than NOI) as a time to deploy capital into stabilized assets. Cap rate compression (prices rising faster than NOI) is a sign to harvest gains and rotate into more defensive plays.

Next​

Cap rates are the entry point to CRE analysis. But financing—how that property is actually bought—is where the leverage game is won or lost. The next article covers the landscape of CRE lending: Fannie Mae and Freddie Mac's agency multifamily programs, commercial mortgage-backed securities (CMBS), life insurance company loans, and bridge financing. Understanding these debt sources is essential because financing costs directly compress or expand cap rate spreads, making or breaking a deal.