Want a fast way to size up a Silicon Valley deal? Cap rate gives you a quick read on income versus price so you can compare opportunities across asset types and micro‑markets. In a region shaped by tech cycles, land scarcity and complex entitlements, understanding cap rates helps you separate durable cash flow from speculative risk. In this guide, you’ll learn the cap rate formula, how investors apply it to retail, industrial, medical office and mixed‑use, and the local drivers that move pricing. Let’s dive in.
Cap rate basics
A capitalization rate is a single‑year return metric: cap rate = Net Operating Income divided by purchase price. It shows how much income a property produces for every dollar you pay. Lower cap rates mean buyers are paying more per dollar of NOI because they perceive lower risk or stronger competition. Higher cap rates mean the opposite.
Cap rate is an investor pricing tool, not a financing metric. It does not reflect loan terms or actual cash flow after debt service. Use it to compare properties at a point in time, then layer in debt, taxes and capital programs in your full underwriting.
How investors use cap rates
Going‑in cap rate
This uses current NOI and current price at acquisition. It is useful for comparing recent sale comps in the same asset class and micro‑market. It reflects in‑place income and current conditions.
Stabilized cap rate
This uses projected stabilized NOI after normalizing vacancy, expenses and rents. It helps you compare properties with different lease rolls, credit quality and short‑term vacancy. It is essential when in‑place rents are below market or when there is near‑term turnover risk.
Exit cap rate
This is the cap rate you assume at sale at the end of the hold period. It drives the reversion value in an IRR model. Sensitivity to the exit cap rate often explains most of the variance in projected returns.
Effective adjustments
Investors often adjust cap rates for deferred maintenance, short lease terms or expense anomalies. These adjustments align price with risk by adding or subtracting basis points from the cap rate you require.
Silicon Valley context
Demand and employment
Tech concentration supports demand for industrial, R&D and higher‑end retail tied to workforce density and spending. Changes in tech employment can quickly affect vacancy and rents, especially for office and retail near major campuses. Health care demand is steadier and driven by demographics and hospital system growth.
Land scarcity and zoning
Limited developable land, high entitlement costs and local design review create supply barriers. These barriers support pricing for infill industrial, R&D and well‑located retail. Municipal fees, inclusionary rules and environmental review also add time and cost to new supply.
Capital and taxes
Under Prop 13, long‑held properties often have lower assessed values, which can reduce operating taxes until a reassessment event. New construction and parcel splits reset assessed value. California regulatory updates, including seismic and energy code changes, can require capital programs that affect NOI and return targets.
Asset shifts to watch
Remote work increased sublease and vacancy in some office nodes, while targeted lab and R&D demand rose in select submarkets. Industrial and flex space benefit from proximity to talent and clients, with limited replacement options. Grocery‑anchored and service‑oriented retail remain resilient in affluent, dense neighborhoods. Medical office with strong system credit and long leases typically trades tighter than independent practice buildings.
Asset class drivers
Retail
- Key drivers: anchor strength and tenant mix, lease structure, location quality, and exposure to e‑commerce. National grocery or pharmacy anchors and NNN leases with investment‑grade tenants reduce risk and usually compress cap rates.
- Local take: Palo Alto, Los Altos and parts of Mountain View can sustain lower cap rates due to high incomes and limited stock. Secondary nodes with weaker anchors or demographics tend to trade wider.
- Due diligence that moves cap rates:
- In‑place versus market rents and rollover schedule.
- Store size, frontage and parking.
- Tenant operating statements for key anchors.
- Deferred capex on façades, roofs and lots.
Industrial and R&D
- Key drivers: functional specs, loading and power, clear height, parking and location near US‑101, I‑280, 237 and major airports. Optionality for lab or last‑mile logistics can add buyer depth and compress cap rates.
- Local take: South Bay and North San Jose with direct tech access often trade tighter than peripheral submarkets. R&D or lab‑capable assets with high power and infrastructure command a premium.
- Due diligence that moves cap rates:
- Utility capacity and improvement costs.
- Environmental history and any hazardous materials.
- Entitlement and density constraints for conversions.
Medical office
- Key drivers: tenant credit, lease term length and escalations, healthcare code compliance, parking and accessibility. Long, credit‑backed leases generally price tighter.
- Local take: Assets leased to major systems such as Stanford Health Care or Kaiser Permanente are often viewed as core. Buildings with independent practices may price wider due to reimbursement and consolidation risk.
- Due diligence that moves cap rates:
- Medical use covenants and equipment ownership.
- Parking ratios and ADA compliance.
- Seismic retrofit scope and cost where applicable.
Mixed‑use
- Key drivers: separate income streams for residential and retail, operating model, zoning, and the quality of ground‑floor retail. Residential is often valued per unit or by GRM, while retail is capitalized.
- Local take: Walkable, transit‑oriented downtowns such as Redwood City, Palo Alto and downtown San Jose see stronger competition and lower blended cap rates. Optionality from convertible residential components can justify tighter pricing.
- Valuation approach:
- Capitalize income streams separately or apply a blended cap rate to combined stabilized NOI after normalizing expenses. Match the method to buyer underwriting.
Benchmark cap rates step by step
- Collect recent comps for the same asset class and micro‑market, ideally within the last 12 months.
- Normalize NOI by removing one‑time items, aligning to market rents and vacancy, and converting leases to a landlord‑net basis.
- Adjust for risk differences: tenant credit, lease term to rollover, physical obsolescence, deferred capital and any entitlement upside.
- Compare the cap rate to yield benchmarks such as the 10‑year Treasury to understand risk premium and cycle position.
- Run sensitivity on exit cap rate and rent growth to see how returns move with realistic swings in the market.
Interpret spreads to rates
Cap rates typically reflect a spread over risk‑free yields plus an equity risk premium. When interest rates rise, higher borrowing costs and a smaller qualified buyer pool can push cap rates up. Fundamentals, liquidity and buyer composition also matter, so spreads do not move one‑for‑one with rates.
Underwriting metrics to track
- Going‑in versus stabilized cap rate, with a clear bridge from trailing to pro forma NOI.
- Lease‑term‑adjusted cap rate that reflects rollover risk and tenant credit.
- Exit cap rate sensitivity, varied plus or minus 100 to 300 basis points, to see IRR and cash‑on‑cash impact.
Quick diligence checklist
- Verify all leases: rent schedules, escalations, options, assignment and sublease clauses.
- Assess tenant credit and concentration risk, and request financials for smaller operators.
- Inspect building systems and capital reserves: roof, MEP, seismic, façade and parking.
- Confirm utility capacity and conversion costs for lab or industrial upgrades.
- Review environmental, zoning, entitlement status and assessed value versus market value.
Common pitfalls
- Comparing unadjusted trailing NOI to stabilized comps.
- Ignoring lease structure differences between NNN and gross.
- Overlooking access or parking constraints that limit demand.
- Excluding capital programs required under California codes from your underwriting.
Practical workflow example
Consider a neighborhood retail center with a strong national anchor and several local inline tenants. Start with the going‑in cap rate on in‑place NOI, then normalize to stabilized NOI by marking inline rents to market and adjusting vacancy. Next, quantify lease‑term differences and any deferred parking lot or roof work as basis point adjustments. Finally, run exit scenarios with a modestly higher cap rate to test reversion risk and returns.
Data sources to track
Use commercial data providers for comps and market analytics. Review broker research from major firms for Silicon Valley snapshots. Check local planning departments, county assessor records and regional economic reports for employment and entitlement context. For healthcare credit context, review public filings from major systems active in the region.
Work with a local advisor
Cap rates in Silicon Valley can vary by hundreds of basis points based on micro‑market, tenant credit, lease term and conversion potential. A local, high‑throughput advisor can help you normalize NOI, benchmark comps and target the right buyer pool or exit path. If you want a fast, confidential review of a property or portfolio, connect with David Taxin to request a confidential property review.
FAQs
What is a cap rate in CRE?
- It is a single‑year return metric equal to a property’s annual net operating income divided by its purchase price, used to compare income to price across assets.
How do Silicon Valley cap rates vary by asset?
- Industrial and core medical office generally trade at lower cap rates than commodity retail or non‑essential office, with mixed‑use blending the two depending on income mix and location.
How do interest rates affect cap rates?
- Cap rates move relative to risk‑free yields plus an equity risk premium, and rising rates often put upward pressure on cap rates as borrowing costs rise and buyer pools adjust.
How should you underwrite mixed‑use cap rates?
- Capitalize retail income and value residential by unit or GRM, or apply a blended cap rate to combined stabilized NOI after normalizing expenses, based on market practice.
What pushes a retail cap rate lower locally?
- Strong grocery or pharmacy anchors, NNN leases with investment‑grade tenants, high‑income trade areas and limited competing supply typically compress retail cap rates.
Which diligence items most change pricing pre‑closing?
- Lease rollover timing, tenant credit, required capital programs, environmental findings and entitlement constraints often drive the largest cap rate adjustments.