Cap rates get quoted constantly in net lease real estate. Here's what they actually measure.
If you've had a sale-leaseback conversation, someone has mentioned a cap rate. Possibly several times. The number gets quoted with authority and accepted without examination — even when the person quoting it isn't entirely certain what it represents.
I've been underwriting net lease real estate for a long time. The cap rate is the first number cited and the last one fully understood. Let me fix that.
What a cap rate actually is
A capitalization rate is the relationship between a property's net operating income and its value. The formula:
Cap rate = NOI ÷ Property value
Or, rearranged to solve for property value:
Property value = NOI ÷ Cap rate
In net lease real estate, the NOI is the annual rent — the tenant pays all other operating costs (taxes, insurance, maintenance) under a triple-net lease structure. So the cap rate becomes simply:
Cap rate = Annual rent ÷ Purchase price
A property purchased for $4,000,000 with annual rent of $280,000 has a cap rate of 7.0%.
That's the math. The hard part is understanding what produces the cap rate on any given deal — because the cap rate doesn't come first. It's the output of a set of underwriting decisions, not the starting point.
Cap rates are market-derived, not calculated
Operators sometimes assume a cap rate is calculated from first principles — that there's a formula that takes the rent, the credit quality, and the property condition and produces a cap rate. There isn't.
Cap rates are derived from market transactions. What buyers are paying for similar properties, in similar locations, with similar tenant credit and lease terms, right now — that's what produces the market cap rate. The buyer's required yield, competitive supply of similar assets, and overall rate environment all influence where cap rates land.
This means two things practically:
First, cap rates by category reflect specific market conditions at a point in time. QSR cap rates are different from healthcare cap rates are different from industrial cap rates — not because the buildings are inherently more or less valuable, but because investor demand, operator credit profiles, and operating risk differ across categories. When those conditions change (rate environment shifts, category-specific operating distress, REIT acquisition appetite fluctuates), cap rates move.
Second, the cap rate on your deal is not the same as the market cap rate for your category. Market cap rates are averages across many transactions. Your deal will price based on the specific characteristics of your business, your real estate, and your lease structure — and those will push your deal above or below the category average.
What moves your cap rate above market
Weaker rent coverage. If your unit EBITDA produces rent coverage right at the category floor — 2x for most operators, 1.5x for QSR — buyers will price that risk with a higher cap rate. Coverage that barely clears the threshold means a business deterioration of 15-20% pushes the tenant into potential distress. Buyers price the probability of that scenario.
The math on what this means for proceeds: a deal priced at a 7.5% cap vs. a 6.5% cap on $280K annual rent = $3.73M vs. $4.31M purchase price. The cap rate difference produces a $577K gap in proceeds. That's the dollar value of the coverage premium.
Secondary or tertiary market location. Investors can sell properties in major markets more easily than properties in smaller markets — higher liquidity commands lower cap rates. A QSR in a major metro trades at a tighter cap than the same QSR in a secondary market, because the re-leasing risk (if the tenant defaults) and the buyer pool for the asset are smaller.
Shorter remaining lease term. A 20-year lease with no existing term burned commands a lower cap rate than a 20-year initial term with eight years already elapsed. The buyer pricing the second is pricing a higher near-term re-leasing risk. More renewal options at reasonable rates partially mitigate this — but a 12-year remaining term at closing will price differently than a fresh 20-year.
Franchise system risk. If your franchise system has brand health issues — declining store counts, litigation, royalty disputes, market saturation concerns — buyers will price that risk into the cap rate. The building is only as good as the business that pays the rent.
What moves your cap rate below market
Strong coverage with improving trend. Rent coverage at 2.5x or higher, with three years of stable or improving EBITDA, is the most direct path to a below-market cap rate. Coverage cushion reduces the probability of default. Buyers price that with a tighter spread.
Strong franchise system in a high-demand category. QSR operators in well-run, growing franchise systems — particularly those with strong unit economics and brand loyalty — attract aggressive buyer interest. When buyers compete for the asset, cap rates compress.
Flagship market location. Prime trade area, high traffic count, strong demographics, with limited competitive supply nearby — that's a location buyers will price with a tighter cap because the re-leasing option is strong. Even if the current tenant defaults, the property has value.
Portfolio volume. Multiple properties closed simultaneously or in a portfolio transaction gives the buyer geographic diversification, reduced per-transaction cost, and scale efficiency. Buyers will price that with a modest cap rate discount relative to individual transactions. On a $12M portfolio vs. three separate $4M deals, the pricing difference can be meaningful.
What the cap rate doesn't tell you
It doesn't tell you whether the deal makes sense for you. A 6.0% cap rate on a property producing $280K annual rent = a $4.67M purchase price. Whether that's a good outcome depends on what you do with $4.67M — if you open two locations that generate $800K/year in combined revenue, the cap rate is just the mechanism. If you pay down SBA debt and reduce covenant restrictions, the cap rate is the price of liquidity. Context determines whether the number is meaningful.
It doesn't tell you what the rent obligation means for your cash flow. The rent is the numerator in the coverage calculation. The question isn't what the cap rate is — it's whether your EBITDA comfortably covers the rent at that cap rate, with margin left for business variability. I've seen operators get excited about a "good cap rate" and not run the coverage math. Coverage is what you live with for 20 years. Cap rate is what you got on day one.
It doesn't tell you the quality of the buyer. A 7.0% cap rate from an all-equity buyer who closes in 45 days is a different transaction than a 7.0% cap rate from a buyer with an acquisition line of credit who closes in 90 days — or doesn't close when the line gets frozen. The number is the same. The certainty is not.
The one thing that matters most
Cap rates are an output of underwriting, not an input. Operators who call asking "what cap rate would Haven offer me?" are asking for an answer that requires knowing: your coverage, your trend, your location, your franchise system, your property condition, your lease structure preferences.
The right question is: "Given my specific situation, what cap rate range would an informed buyer target for my deal — and what would change that range?"
That question gets answered in the first working session, with actual numbers.
Want to understand where your deal would price and why? I run Haven's underwriting. A 45-minute working session with your actual numbers produces a specific answer.