Cap Rates and Interest Rates

The single most important relationship in commercial real estate pricing is the one between cap rates and interest rates. When the cost of borrowing rises, the yield an investor demands from a property rises with it, and because cap rate equals net operating income divided by price, a higher cap rate means a lower price. This is how the band-of-investment derivation works, where the overall cap rate is a weighted blend of debt and equity return requirements. A buyer who can borrow at 6% will not accept a 5% cap rate unless rent growth is expected to make up the difference, and that expectation is priced in slowly, not instantly. The 10-year Treasury is the benchmark because it is the risk-free alternative; the 10-year Treasury constant maturity series (DGS10) from FRED, standing at 3.70% as of late September 2026, sets the floor for every risk premium discussion that follows.

That floor is why the spread matters more than the level. A 5.5% cap rate with Treasuries at 2% is a rich deal; the same cap rate with Treasuries at 5% is a giveaway. The cap rate spread over the 10-year Treasury, currently 2.2 percentage points on the all-property average, is the number a broker actually watches. It tells you whether you are being paid to take leasing risk, tenant credit risk, and liquidity risk, or whether you are giving those risks away. When the spread compresses below its historical average of 1.9 percentage points, prices are stretched; when it widens, the correction is already underway. You do not need to forecast rates to use this; you need to know where the spread sits today and whether it compensates you for what can go wrong between signing and closing.

The cap rate spread over the 10-year Treasury is the risk premium for owning real estate instead of a risk-free government bond. The all-property average cap rate of 5.9% minus the 3.7% Treasury yield gives the 2.2 percentage point spread, but that varies by property type, with industrial at 5.2% (a 1.5 point spread) and office at 6.8% (a 3.1 point spread) at the 2026 H1 survey date. The CBRE survey that publishes these figures updates every six months, so the exact numbers you see when you read this may already be a cycle old; the publisher is the source for the real figure. What does not change is the logic: a wider spread means the market fears rent declines, vacancy, or a recession, while a narrow spread means capital is chasing yield and underwriting future growth optimistically.

The spread does the analytical work that a raw cap rate cannot. A 6% office cap rate in a 3.7% Treasury environment is historically average compensation, while the same 6% cap rate with Treasuries at 5% is a warning that the market expects NOI to fall. The range across property types, 1.8 to 2.6 percentage points in 2026 H1, is where you separate core assets from risky ones. For a buyer, the spread is the first screen: if the spread is below 2 points on a non-core asset, you are overpaying for risk that a bond index gives you cheaper. For a seller, the spread tells you when to hold: listing into a compressing spread means accepting a lower price than the last deal in your submarket closed at.

Do cap rates rise with interest rates? They do, but not on the same day, and not one-for-one. Cap rates lag rate changes because the two markets clear at different speeds. Treasuries reprice in milliseconds on the Fed's announcement; commercial real estate reprices when a deal actually closes, which takes 30 to 90 days of due diligence, financing, and negotiation. A seller who listed at a 5% cap rate when the 10-year was at 3.5% does not drop the price the morning the Treasury hits 4.2%; they wait, the property sits, and only after a failed marketing period does the effective cap rate move. That lag is why the cap rate spread over the 10-year Treasury compresses when rates rise and widens when they fall, and it is why the spread is mean-reverting rather than constant.

The lag creates the opportunity, and the trap. The buyer who watches the spread knows that a 100 basis point jump in the 10-year Treasury will eventually push cap rates up by roughly 50 to 70 basis points, not the full 100, since part of the increase is absorbed by lower growth expectations.94% (the 1 divided by 1.06 formula), so a buyer who waits for the lag to resolve pays less, while a seller who refuses to adjust faces a stale listing that eventually sells at a steeper discount. The failure case is the investor who uses the current Treasury yield as the discount rate in a discounted cash flow model and ignores that the cap rate is the market's current yield, not the required total return; that mismatch produces a bid that is either too high or too low by the time the spread normalizes.

Negative leverage real estate is the situation where the interest rate on the loan exceeds the cap rate on the property, and it is the fastest way to turn a supposedly income-producing asset into a cash drain.The cap rate is an unlevered return, the return on the total property value ignoring debt, and the moment your cost of capital is above it, every dollar of debt reduces your cash-on-cash return below what the property itself earns. This is not a temporary condition that fixes itself; it persists for the life of the loan unless rents rise or interest rates fall, and neither is guaranteed.

The math is brutal and immediate.The appraisal institute's band-of-investment method shows why: the overall cap rate is a weighted average of the mortgage constant and the equity dividend requirement, so when the mortgage constant rises, the cap rate must rise to keep the equity component positive. If you cannot push the purchase price down to a cap rate above the interest rate, the deal only works with rent growth or refinancing, and betting on either is how negative leverage becomes a forced sale.

The cap rate spread treasury relationship is the single most reliable pricing signal in commercial real estate because it strips out the absolute level of rates and isolates the risk premium. When the spread widens, it is not because the economy is strong; it is because lenders and buyers are demanding more compensation for the same cash flow, which happens in recessions, credit crunches, and periods of high vacancy. When the spread narrows, capital is confident, and it accepts a lower premium for the same risk. The historical average spread of 1.9 percentage points over 2007-2025 is the baseline; the current 2.2 point all-property average is above it, which suggests the market is pricing in more risk than the long-run norm, but still below the 3-point spreads that marked the 2008 and 2020 bottoms in pricing.

You use this by comparing the spread on the asset class you are buying to the spread on the Treasury, not by comparing cap rates across property types. A 5.2% industrial cap rate with a 1.5 point spread is not automatically better or worse than a 6.8% office cap rate with a 3.1 point spread; the industrial asset has less vacancy risk, shorter downtime, and stronger rent growth, so it deserves the tighter spread. The failure case is the buyer who chases the highest cap rate without asking why the spread is wide: a wide spread on a class B office building in a declining secondary market is not a bargain, it is a trap, since the NOI itself is at risk. The spread tells you the market's fear level, and the asset's actual cash flow tells you whether that fear is justified.

Do cap rates rise with interest rates is the question every first-time rental investor asks, and the answer from transaction data is a qualified yes with a lag and a dampened magnitude. The CBRE cap rate survey, which compiles actual and asking cap rates by property type, shows that a 100 basis point rise in the 10-year Treasury historically pushes all-property cap rates up by only 40 to 60 basis points within two quarters, since the risk premium compresses when the economy is growing and widens when it is not. The 2026 H1 survey data, with industrial at 5.2%, multifamily at 5.4%, retail at 6.1%, and office at 6.8%, reflects a rate environment where the 10-year sits at 3.70%, and the all-property average of 5.9% carries a 2.2 point spread. That is the number to watch, not the cap rate in isolation.

The practical implication is that you do not wait for the Fed to cut before buying, because the market has already priced the expected path of rates into the spread. The failure case is the investor who sits on cash waiting for the 10-year to hit 4.5%, then buys at a 6.5% cap rate that looks great but reflects a deteriorating economy where NOI is falling, and the spread never compensated for the decline. Instead, buy when the spread is wide and the absolute cap rate is high, even if interest rates are also high, because the spread is what pays you for risk. A 6.5% cap rate with a 3.0 point spread over a 3.5% Treasury is a better risk-adjusted buy than a 5.0% cap rate with a 1.5 point spread, since the former has more room for both cap rate compression and NOI growth.

Before you make an offer, build a sensitivity table in Microsoft Excel using the Data Table (What-If Analysis) tool, which shows how value changes with cap rate and NOI assumptions. The steps are exact: put the cap rate in the left column and the NOI in the top row, select the range, go to Data → What-If Analysis → Data Table, and point the row input cell at the NOI cell and the column input cell at the cap rate cell. The output grid is the price you can pay for each combination, and it immediately exposes whether your bid is justified or a fantasy. Google Sheets has a similar Data Table feature, but it requires an array formula and manual setup, so the failure case is a spreadsheet that returns errors because the user did not enter the formula as an array; if the grid does not populate, re-enter the formula with Ctrl+Shift+Enter.

Here is what the table tells you that a single cap rate cannot: the exit cap rate matters as much as the going-in rate. A property bought at a 5.4% cap rate with a 5.7% exit cap rate loses value on sale, and the table quantifies that loss before you sign. For a 1 percentage point increase in the cap rate, the value drops by approximately 15.1% (1 divided by 6.6, expressed as a percentage), so a 6% to 7% move wipes out more than a year of NOI. The sensitivity table is the tool that forces the conversation about what happens if the 10-year Treasury rises 100 basis points after closing; the cap rate spread treasury relationship tells you the cap rate will follow, and the table tells you what that does to your equity. Use it on every deal, and use the worst-case column as your walk-away number.

The cap rate is a current yield, not a total return, and confusing the two is the most expensive mistake in commercial real estate. A 5% cap rate on a property with flat rents and a 6% exit cap rate produces a negative total return, because the sale price falls more than the income covers. Geltner et al. define total return as the cap rate plus income growth plus appreciation yield, and the three components are rarely in balance; a property with a 5% cap rate and 3% rent growth has a total return near 8%, while a 7% cap rate with 2% rent decline has a total return near 5%. The cap rate only equals the discount rate when there is no growth and no reversion, which is a theoretical construct, not an investment plan. For a small landlord, this means a low cap rate on a stable, growing market can be smarter than a high cap rate on a declining one, because the total return is what pays the bills over a decade.

The failure case is the seller who markets a 6.8% office cap rate as a high-yield investment without mentioning that the NOI is declining 4% annually, making the total return negative. The buyer who focuses only on the cap rate spread treasury relationship and not on the NOI trend will overpay. The same logic applies to the difference between the going-in cap rate and the exit cap rate; a property bought at a 5.4% cap rate and sold at a 6.4% cap rate loses roughly 15.6% of its value on exit, which the income over the hold period may not offset. The cap rate is a snapshot of the current yield; the total return is a movie, and the sensitivity table is the script.

9%, so a 6% to 7% cap rate move wipes out a year of NOI, and the sensitivity table is the tool that forces that conversation before you sign.