Cap Rates and Interest Rates

If you've talked to anyone about selling a net lease property, you've heard the term "cap rate." It's the single number most buyers use to compare deals and translate rent into price. Cap rates also respond to the broader market, especially interest rates. Understanding both helps you make sense of valuations and timing.

For the full set of factors that affect value, see the pillar guide, What Determines the Value of a NNN Property?

What Is a Cap Rate?

The capitalization rate is a property's net operating income (NOI) divided by its price:

Cap Rate = NOI ÷ Price

Flip it around and you get the formula buyers use to set price:

Price = NOI ÷ Cap Rate

Hypothetical example: A property producing $100,000 of NOI:

• At a 6.0% cap rate: about $1,667,000
• At a 6.5% cap rate: about $1,538,000
• At a 7.0% cap rate: about $1,429,000

(Illustrative only. These are not market quotes.)

Two things stand out. First, a lower cap rate means a higher price. Second, small changes in cap rate produce large changes in value. That's why owners and buyers pay so much attention to it.

What a Cap Rate Represents

A cap rate is the buyer's first-year, unleveraged return: the return before any loan. It reflects how the buyer views:

• Risk: tenant credit, lease term, landlord responsibilities, and location.
• Growth: scheduled rent increases and the long-term outlook for the site.
• Alternatives: what else the buyer could do with the money, including other properties, bonds, or savings.

Lower cap rates go to properties buyers see as lower risk or higher growth. Higher cap rates compensate for more risk or less growth. The other pages in this series explain each of those risk factors:

• Lease Term Remaining
• NN vs. NNN Leases
• Tenant Credit and Guarantees
• Rent Increases and Renewal Options
• Location
• Building Age and Condition

How Interest Rates Affect Cap Rates

Interest rates influence cap rates in a few ways.

1. Borrowing costs. Many buyers use financing. When loan rates rise, the same purchase produces less cash flow after debt payments, so leveraged buyers may need a higher cap rate to make the numbers work. When rates fall, the reverse can happen.

2. Competing investments. Net lease is often compared with safer income investments, such as U.S. Treasury bonds. When Treasury yields rise, some investors expect a higher return from real estate to justify the extra risk and lack of liquidity. A commonly watched benchmark is the 10-year Treasury yield, which you can track for free on the Federal Reserve Bank of St. Louis's FRED database (series DGS10).

3. Buyer sentiment. Rate changes affect how confident buyers feel about the economy and about where values are headed.

It's Not a One-to-One Relationship

Cap rates don't move in lockstep with interest rates. Some important nuances:

• There's often a lag. Sellers' expectations can take time to adjust, so transaction volume may slow before pricing changes.
• All-cash buyers are less directly affected by loan rates, though they still consider alternative returns.
• Different segments move differently. Properties with long leases and strong guarantors may react differently than short-term or smaller-credit deals.
• Demand matters too. The number of buyers, including those completing 1031 exchanges, can support pricing even when rates change.

The Federal Reserve sets the federal funds rate, which influences short-term borrowing costs. You can follow its decisions on the Federal Reserve's FOMC page. Longer-term rates, including commercial mortgage rates, are influenced by many factors beyond the Fed.

In our work, cap rates tend to follow the direction of interest rates, but not on the same day. Sellers who price to the current rate environment are the ones who get to the closing table; waiting for yesterday's pricing is usually what keeps a property on the market.

Angelo Iacobelli, Managing Partner

Why Published Cap Rate Averages Can Mislead

Owners often see average cap rates quoted in industry reports. Those can be helpful for spotting trends, but be careful applying them to your property:

• Averages blend very different leases, terms, tenants, and locations.
• Reports may be based on asking prices, not closed sales.
• Market data can be months old by the time it's published.

Your property's value depends on its specific lease and location, priced against current buyer demand.

Timing a Sale Around Interest Rates

It's natural to want to sell at the "right" time in the rate cycle, but rates are hard to predict. Some things owners consider:

• Your lease term keeps declining whether rates move or not. Waiting for lower rates can mean selling with less term. See Lease Term Remaining.
• Your own plans (retirement, estate planning, reinvestment) often matter more than trying to time the market.
• Taxes: If you're considering a 1031 exchange, remember that the rate environment affects your replacement property too. Talk with your CPA or attorney about timing and tax implications. The IRS provides an overview of like-kind exchanges.

Frequently Asked Questions

What is a good cap rate for my property? There's no universal number. The right cap rate depends on the tenant, guarantee, lease term, rent increases, landlord responsibilities, location, and current market conditions. A valuation should be based on your specific lease.

If interest rates drop, will my property be worth more? Possibly, but not automatically. Lower rates can help buyer demand, but cap rates don't move one-for-one with rates, and other factors, like your remaining lease term, keep changing.

Why do cap rates differ so much for the same tenant? Because the lease terms, guarantor, remaining term, location, and building condition differ from one property to the next, even when the brand is the same.

Is a lower cap rate better for me as a seller? Yes. A lower cap rate on the same NOI means a higher price. For a buyer, it means a lower initial return.

This article is general information, not tax, legal, or investment advice. Consult your own advisors before acting.