Cap Rate

Capitalization rate (cap rate) is the most widely used metric in commercial real estate valuation. It expresses the relationship between a property's net operating income and its market value as a percentage. Cap rate serves as both a valuation tool and a shorthand for investment risk-lower cap rates indicate lower perceived risk (and higher prices), while higher cap rates signal higher risk (and lower prices).

The cap rate is calculated by dividing a property's NOI by its purchase price or current market value. A property generating $100,000 in NOI purchased for $1,666,667 represents a 6.0% cap rate. This metric allows investors to quickly compare properties across markets, tenant types, and asset classes on an apples-to-apples basis.

In the NNN sector, cap rates vary significantly based on tenant credit quality, remaining lease term, rent escalation structure, and property location. Investment-grade single-tenant NNN properties (McDonald's, Walgreens, Dollar General) typically trade at 5.0-6.5% cap rates, while non-investment-grade tenants trade at 7.0-9.0%+. Each 25 basis point change in cap rate represents a significant change in property value.

Cap rate movements are influenced by interest rates, investor demand, market conditions, and economic outlook. The spread between cap rates and Treasury yields (or borrowing costs) determines leverage attractiveness. When cap rates exceed borrowing costs, positive leverage exists, enhancing equity returns. Understanding cap rate dynamics is arguably the most important skill for NNN investors.

Cap rate is the primary language of NNN investment pricing. Every acquisition decision ultimately centers on whether the cap rate adequately compensates for the property's risk profile. Investors must understand that a low cap rate doesn't always mean a bad deal-a 5.25% cap on a Chick-fil-A with 15 years remaining may offer better risk-adjusted returns than a 7.5% cap on a local restaurant with 3 years left. The cap rate spread over borrowing costs determines whether leverage enhances or dilutes your equity returns, making this metric inseparable from financing analysis.

NNN cap rates in 2025-2026 typically range from 5.0% to 8.0%+ depending on tenant credit quality and lease terms. Investment-grade tenants like McDonald's and Chick-fil-A trade at 5.0-5.75%. National retailers like Dollar General and AutoZone trade at 6.0-7.0%. Non-investment-grade local tenants typically trade at 7.5-9.0%+. Cap rates have been influenced by elevated interest rates keeping the 10-year Treasury above 4%.