Cap Rates Explained: What a Cap Rate Tells You About Commercial Property

Cap rates come down to one relationship: the net income a property can sustain drives what buyers will pay for it. A capitalisation rate, or cap rate, expresses a property’s annual net operating income (NOI) as a percentage of its price or value. The formula is simple. The hard part is deciding which income and which rate belong in it, and that takes evidence about the lease, the tenant, the building and the market. In this article, we’ll explain what a cap rate measures, how to calculate it, what a good cap rate looks like in Australia, and how small changes in the rate move a property’s value.

What a Cap Rate Measures

A cap rate measures the property’s income before finance and income tax. It is not your total return, because it leaves out capital growth, transaction costs and how you fund the purchase.

Two buyers can buy the same building at the same cap rate and get very different cash returns, because their deposits, loans and tax positions differ. Keep the property’s performance separate from your personal cash flow.

A gross yield uses rent before property expenses, so it usually looks higher. Before you compare two properties, confirm what each advertised percentage actually includes.

How to Calculate a Cap Rate

The formula is:

Annual net operating income ÷ property price or value × 100 = cap rate

For example, a property earning $90,000 a year in rent with $15,000 of unrecovered recurring expenses has $75,000 in net operating income. At a price of $1.25 million, the cap rate is 6%.

If the owner is registered for GST and can claim the relevant credits, use GST-exclusive income and expenses, and have your accountant confirm the treatment for the sale. Also be clear about whether you are using the income the property earns today or a stabilised estimate.

Check What Sits Inside Net Income

Start with the lease, the rent ledger, the outgoings reconciliation and the expense records. Owner-paid management, insurance, rates and recurring maintenance reduce NOI. Outgoings the tenant reimburses should not be deducted twice.

Loan repayments, depreciation and income tax sit outside NOI. Major capital works need their own allowance too, because they are not recurring operating costs. Our article on maximising commercial real estate returns keeps property yield, return on equity and cash flow apart so each assumption stays in the right calculation.

What Is a Good Cap Rate in Australia?

There is no universal good cap rate. A useful range comes from settled sales of similar properties: similar location, building quality, tenant, lease terms, land size and income assumptions.

For broad context, Opteon’s market outlook, published on 30 March 2026, reported national average cap rates from its outlook event of 6.2% for office, 5.7% for retail, 5.4% for industrial and 5.5% across all property. The article doesn’t break these down into prime, secondary, metropolitan or regional property, so treat them as context rather than valuation bands.

Yields also vary widely between cities. realcommercial.com.au’s Commercial Yield Report, released on 2 April 2026, found Brisbane had the highest yields of the capital cities across industrial, office and retail, with Sydney and Melbourne at the lower end. Those are gross yields, not cap rates, because owner expenses haven’t been deducted.

Use national figures only as a first sense-check. For any real property, whether a prime CBD building, a secondary suburban one or a regional specialist asset, build a local range from comparable settled sales, and recalculate each sale on the same NOI basis. Selling agents, independent valuers and sales databases can help you find the transactions. Check the sale date, lease position, incentives and the NOI that was actually used before you rely on a reported rate.

How Cap Rates Change Property Value

Turn the formula around to estimate value:

Annual net operating income ÷ cap rate (as a decimal) = indicated value

With $75,000 of sustainable NOI, a 5% cap rate indicates a value of $1.5 million, 6% indicates $1.25 million, and 7% indicates about $1.07 million.

A move from 6% to 7% is 100 basis points. In this example, the value falls by about 14% even though the rent hasn’t changed. That is why a higher cap rate means a lower value when income stays the same.

These figures illustrate the maths. They are not forecasts, and they leave out purchase costs, finance, tax and adjustments for the individual property. Our article on how to value commercial property explains why comparable sales and the building itself have to support the result.

Cap Rates and Interest Rates

Borrowing costs affect how much buyers can pay and what return they need, but cap rates don’t follow the cash rate automatically. Leasing conditions, the supply of capital, building quality and recent sales all influence pricing.

In its October 2026 Financial Stability Review, the Reserve Bank says “fundamentals continue to improve across most commercial real estate markets”, while also pointing to higher interest rates and elevated uncertainty. That is a view of the market overall, not a forecast for every sector or property.

Test your refinancing costs and your exit value separately. A cap rate above your loan rate does not prove the property is cash flow positive once principal repayments, vacancy and capital works are counted. Our guide to positively gearing your commercial property shows how to run those numbers.

Check the Income Before You Make an Offer

Before you rely on a cap rate, check the income behind it:

• Match the rent being paid to payment records and comparable signed leases
• Identify incentives, arrears and expenses the owner keeps
• Check the tenant’s financial strength, guarantees, expiry dates and options
• Price any defects, compliance work and likely capital replacements
• Model vacancy, re-leasing costs, refinancing pressure and the cap rate when you sell

Record each assumption with its supporting document so your advisers can test the model. Our articles on commercial lease negotiations and commercial property due diligence cover the lease and the wider checks.

A buyer’s agent such as Revolve Commercial can test an advertised cap rate against the lease and the local sales evidence. If you have a property in mind, book a call and bring the lease, the price, the expense records and any sales evidence you have.

Frequently Asked Questions

Can You Use a Cap Rate for a Vacant Property?

There is no current income to capitalise. A valuer may estimate the income once the property is leased, then allow for the time, incentives and costs needed to get there.

Is a Cap Rate the Same as a Discount Rate?

No. A discount rate converts future cash flows into a present value. A cap rate converts one representative year’s income into an indicated capital value.

What Is a Reversionary Yield?

It estimates the yield once the income moves to an assumed market rent. The result depends on the lease timing and whether that rent is achievable.

Can Owner-Occupiers Use Cap Rates?

Yes, as an investment cross-check using market rent. Whether the building suits your business, and the cost of owning versus leasing, still matter.

Should Stamp Duty Be Included in a Cap Rate?

A conventional cap rate uses price or value only. You can calculate a separate return on the total purchase cost, including stamp duty and fees, as long as you label it clearly.

Conclusion

A cap rate is only as good as the net income behind it. Calculate it on verified NOI, compare it with local settled sales rather than national averages, and remember that a small change in the rate can move the value a long way.

Want a Second Opinion on a Cap Rate?

Advertised yields and cap rates are often calculated in different ways, which makes properties hard to compare. At Revolve Commercial, we help investors test the income, the lease and the sales evidence behind the number.

If you would like to talk through a property you are considering, book a free call with an experienced commercial buyer agent at Revolve Commercial today.

Disclaimer: This article provides general information only and does not constitute financial, legal or tax advice. Obtain independent advice suited to your circumstances before acting.