Selecting Discount and Cap Rates in Commercial Real Estate: A Lender & Investor Playbook

Alketa Kerxhaliu
Oct 20
26 min read

Introduction

Selecting appropriate discount rates and capitalization rates (cap rates) is a critical step in commercial real estate valuation and underwriting. These rates directly influence property values, investment decisions, and loan terms. Yet determining the “right” rate is as much art as science – requiring market evidence, analytical cross-checks, and sound judgment. This playbook provides a structured approach for U.S. real estate lenders and investors to evidence-based rate selection, triangulation techniques, and common pitfalls to avoid. It also highlights how perspectives differ between debt lenders and equity investors. Throughout, we use U.S. market terminology and conventions (e.g. cap rates in percentage terms, discount rates as required IRRs) and maintain an analytical, educational tone suitable for a top-tier consulting audience.

Before diving in, it’s important to clarify these terms:

Cap Rate (Capitalization Rate): The ratio of a single year’s stabilized net operating income (NOI) to property value. It is essentially a one-period income yield measure. For example, a property with $1,000,000 NOI selling at a $20,000,000 price has a 5% cap rate. Lower cap rates indicate higher valuations (and often lower perceived risk), whereas higher cap rates indicate lower valuations (higher risk or weaker growth prospects). Cap rates are widely used for quick valuations and comparisons in CRE. However, a cap rate is a snapshot – it ignores explicit future cash flow changes and assumes the current income is sustainable.
Discount Rate: The required total return on investment used to discount future cash flows in a DCF (discounted cash flow) analysis. It reflects the investor’s required IRR (internal rate of return) for the property given its risk and growth outlook. The discount rate is applied over a multi-year holding period and thus incorporates expectations of income growth, terminal value, and risk over time. In a stable growth scenario, the discount rate relates to the cap rate by the formula: Discount Rate ≈ Cap Rate + Growth Rate. This is derived from the Gordon growth model, where value = next year’s NOI / (discount rate – growth). For instance, if an asset’s NOI is expected to grow ~2% annually and investors require ~8% total return, the going-in cap rate would roughly be 6% (8% – 2%).

Why getting these rates right matters: A small change in cap or discount rate can swing a valuation significantly. For investors, it can be the difference between pursuing or passing on an acquisition; for lenders, it affects appraised value, loan-to-value (LTV) ratios, and ultimately the safety of the loan. Given the stakes, a rigorous approach to selecting these rates – grounded in market data and analytical cross-checks – is essential. The sections below serve as a playbook, starting with gathering evidence, then triangulating a supportable rate, warning of common pitfalls, and finally tailoring to the perspective of lenders vs. investors.

Evidence-Based Rate Selection: Primary and Secondary Sources

A sound evidence-based approach begins with gathering both primary and secondary market data on cap rates and required returns. Different sources provide pieces of the puzzle; combining them provides a clearer picture. Table 1 summarizes key evidence sources, with their typical usage, pros, and cons.

Table 1 – Key Evidence Sources for Cap Rates and Discount Rates

Source Type	Examples & Data Obtained	Pros (Reliability)	Cons/Considerations
Comparable Sales (Primary)	Recent property sales in the same market/asset type; extract cap rates by dividing NOI by sale price. Also called market comps.	Direct market evidence: reflects actual prices investors paid. Typically most influential: Considered the most accurate indicator if truly comparable. Provides context on pricing and yields for similar assets.	Data lag: recorded sales can be months old, possibly not reflecting current conditions. Must ensure “apples to apples” – adjust for differences in lease terms, NOI calculation (e.g. treatment of reserves), asset quality, etc. Thin trading in some segments (few comps) or lack of recent sales in downturns can limit usefulness.
Investor Surveys (Secondary)	Periodic surveys of investor sentiment and criteria. E.g. PwC/ULI Investor Survey, CBRE Cap Rate Survey, RERC reports, etc. These often report average cap rates, discount rates, and growth expectations by sector and class.	Broad market perspective on required returns. Captures current sentiment and forward-looking expectations (real-time snapshot of “market thinking”). Readily available for major markets & property types; some surveys have decades of data for trend analysis. Useful as a benchmark or starting point – a “wisdom of the crowd” of professional investors.	Supporting role only: Surveys should not be sole basis of a cap rate conclusion. They reflect opinions (which may lag or lead actual transactions) and often lag one quarter behind market shifts. Definitions can vary: ensure understanding of survey assumptions (stabilized vs value-add, etc). May not capture local sub-market nuances (most are national/regional data). Combine multiple survey sources to avoid bias.
Broker & Appraiser Opinions (Secondary)	Informal interviews or published market outlooks from active brokers, appraisers, and consultants. E.g. brokerage house research reports, cap rate opinion polls, or direct calls to market participants.	Provides anecdotal, on-the-ground insight. Practitioners can offer real-time color on deals in progress, buyer demand, and whether markets are softening or heating. Especially useful in volatile markets when closed sale data is sparse or stale – brokers know where offers and asks are trading. Can segment by quality: brokers often differentiate cap rates for Class A/B/C, etc., in a specific submarket.	Subjective and potentially biased: Brokers may be optimistically biased (to encourage deals) or have limited sample size. Should be cross-verified with data (don’t rely on a single broker quote). Requires effort: conversations or digging into research reports. Local focus – great for micro insights, but might not reflect wider investor sentiment.
Historical Performance Data (Secondary)	Track record of the asset or similar assets: e.g. historical cap rate trends, returns from NCREIF or REIT indices, prior holding period IRRs on comparable properties.	Puts current rates in context: e.g. comparing today’s cap rates to 5- or 10-year averages can indicate if pricing is aggressive or conservative. Reveals cycle patterns: how cap rates moved in past downturns/recoveries (helpful for scenario analysis). Actual realized returns (if available) show what level of discount rate was achieved historically for given risk profiles.	Backward-looking: past performance may not predict future conditions. Market structure, interest rates, and risk appetite change over time. Data on private deals can be limited; indices (like NCREIF) are aggregates that may not reflect a specific property’s situation. Use only as a sense-check or to inform risk premia (e.g. “value-add deals historically returned ~12–15%, does my discount rate align with that?”).

Using comparable sales (market extraction): In practice, appraisers and analysts give strong weight to recent comparable sales. If sufficient comps exist, analyze their cap rates and the context of each sale. For example, verify how each comp’s NOI was computed (were one-time expenses or reserve contributions handled consistently?). Look at buyer type – was it an owner-user or an investor? – and motivation (some sales may not be arm’s-length or might include unusual conditions). The goal is to derive a market-derived cap rate range for assets similar to the subject. If the subject property has different risk factors (e.g. shorter lease term or older building than the comps), adjust the cap rate upward or downward appropriately as a qualitative judgment. Comparable sales data is powerful, but as noted, beware of data lag: in rapidly changing markets, closed deals from six months ago might reflect a very different interest rate environment. Recent signed LOIs or contracts (even if not closed) can sometimes provide more up-to-date cap indications if you can obtain that intel.

Using investor surveys: Surveys are excellent for understanding broad market expectations. For instance, PwC’s Investor Survey (formerly Korpacz) and others publish ranges for going-in cap rates, terminal cap rates, and discount rates by property type and class. These can serve as a reality check: Is your concluded cap rate in line with what a range of investors say they require in similar deals? If not, there should be a defendable reason. Surveys also often provide insight into trends (e.g. if investors are raising return requirements due to economic uncertainty). That said, as Newmark’s guidance notes, surveys are generally supporting data – useful to understand real-time dynamics, but shouldn’t override direct market evidence. They can sometimes indicate market sentiment shifts before they fully show up in closed sales. For example, if transaction volume is low, surveys or sentiment indexes might be your best gauge of where cap rates would be if a deal occurred today. Use multiple survey sources if possible (e.g. compare PwC, CBRE, RERC) – each has different respondent pools and methodologies, and a consensus among them is more compelling than any single source.

Broker opinions and interviews: Especially for niche markets or property types, directly talking to brokers, appraisers, or other market participants can fill in gaps. An appraiser might conduct “market participant interviews” as part of a valuation, asking questions like “What cap rate are buyers currently using for Class B offices in this suburb?” These interviews yield anecdotal but vital local insights. For example, brokers might share that investors are now underwriting higher vacancy or capital reserves, effectively pushing effective cap rates up even if headline pricing hasn’t fully adjusted. Such qualitative color can help interpret why hard data (like last quarter’s sales) might soon shift. When using these opinions, always document the source and consider potential bias. If a broker who primarily sells trophy assets says “cap rates are 5%,” remember that might apply to prime core deals and not the entire market.

Historical asset performance: While the focus is on current forward-looking rates, historical performance provides context for risk. If a property type historically delivered, say, 10% annual returns over a full cycle, an investor’s required discount rate might be built starting from that baseline and then adjusted for current conditions (risk-free rate, risk premiums, etc.). Additionally, analyzing historical cap rate trends can prevent anchoring to an unusual data point. For instance, if cap rates in a sector hit record lows last year due to exceptionally cheap debt and bullish growth assumptions, a lender or investor should question whether using that same cap rate today is appropriate. Often, looking at a 10-year average cap rate for the asset type, and then considering today’s interest rates and growth outlook relative to history, will inform a more grounded selection. Ultimately, historical data should not substitute for current market inputs, but it can inform whether current rates appear frothy or conservative in a longer-term context.

Triangulating the Right Rate: Multi-Method Approach

Given the importance of these rates, best practice is to triangulate – i.e. approach the problem from multiple analytical angles to cross-check and reinforce your conclusion. Different methods have different strengths, and using them in combination provides a more robust result. Key triangulation techniques include direct market extraction, the Band of Investment method, DCF cross-checks (e.g. the Gordon growth model), and market-derived formulas like the debt coverage method. Each method essentially tackles the question: “What should the cap rate or discount rate be?” from a slightly different perspective. We outline these below and summarize in Table 2.

Table 2 – Methodologies to Derive/Validate Cap and Discount Rates

Method & Description	How It Works / Formula	When to Use (Pros)	Limitations / Considerations
Direct Market Extraction (Sales Comparison)	Derive cap rate from comparable sales by dividing each property’s stabilized NOI by its sale price. Analyze resulting cap rate range and central tendency.	Whenever sufficient recent comps are available (primary method). Simple and grounded in reality: Reflects actual investor behavior. Ensures your rate is anchored to market pricing, avoiding theoretical or overly optimistic inputs.	Requires truly comparable data – adjustments needed if comps differ on NOI treatment or asset characteristics. Data lag and scarcity can be issues (as discussed). Yields a cap rate but not a discount rate directly (though one can infer discount if growth is estimated).
Band of Investment ("Mortgage-Equity" Method)	Calculates an overall cap rate as a weighted average of returns to debt and equity. Classic formula: R = (M *R<sub>m</sub>) + ((1–M)* R<sub>e</sub>), where M = LTV (loan-to-value as %), R<sub>m</sub> = mortgage constant (annual debt service / loan principal), and R<sub>e</sub> = required equity cash-on-cash rate (also called equity dividend rate). Essentially, it’s a WACC for the property’s capital stack.	Useful as a analytical check or when sales data is sparse. Incorporates current debt market conditions (interest rates, typical LTV) and equity return requirements, making it very market-sensitive. Especially relevant for stabilized properties where typical financing terms are known. Lenders appreciate this method as it mirrors underwriting: ensures the derived cap rate supports both lender’s and equity’s yield needs.	Garbage-in, garbage-out: you need realistic inputs for R<sub>e</sub> and R<sub>m</sub>. Equity return (R<sub>e</sub>) should come from investor surveys or similar evidence; mortgage terms from current lending quotes. Only gives a cap rate (focused on year-one cash flows). Doesn’t directly yield the discount rate (though R<sub>e</sub> is related to equity IRR sans appreciation). Example: Suppose 80% debt at a 6% interest (constant 8.59%) and investors want a 15% equity cash yield; band-of-investment computes cap ≈ 9.9%. This shows how higher debt cost and equity return push the cap rate higher.
Discounted Cash Flow (DCF) Cross-Check Gordon Growth Model	Use a multi-year cash flow projection and chosen discount rate to ensure it aligns with an implied cap rate and exit value. The Gordon Growth model formula: Cap Rate = Discount Rate – Growth Rate. In a stable growth scenario, if you assume a long-term NOI growth (g), then choosing a discount rate (r) implicitly means a cap = r – g to be consistent. Likewise, solve for r = cap + g. A DCF cross-check means you run a full DCF (with an exit cap assumption) to see if the NPV yields a value consistent with direct cap. If not, assumptions may be misaligned.	Powerful for triangulating discount rates from cap rates or vice versa. Ensures internal consistency between short-term and long-term assumptions. Especially useful when growth expectations are significant or when analyzing value-add deals (where year-one cap is low but growth is high). Can reveal if one is using circular logic: e.g. if you plug a discount rate just to get the target value, the implied growth or exit assumptions might be unreasonable. Instead, explicitly checking cap vs growth vs discount makes assumptions transparent.	Requires a defensible growth rate (g) assumption. Overly rosy or pessimistic g will skew the relationship. In shorter hold analyses, the chosen exit cap adds another variable – one typically assumes exit cap = entry cap + some spread for aging or market softening. Those assumptions need market support. The Gordon formula is most directly applicable to stabilized, perpetual holdings. If holding period is finite, do full DCF with an exit cap and ensure that discount rate selection produces a sensible purchase price relative to NOI.
Debt Coverage-Derived Rate ("Lender’s DSCR method")	Derive a cap rate that ensures a target Debt Service Coverage Ratio (DSCR) given current loan terms. Formula (Gettel’s formula) in simplified form: R = M *R<sub>m</sub>* DSCR. This comes from solving for value such that NOI/Value = cap rate produces the required DSCR on the debt. (Effectively a variant of band-of-investment focusing on debt service.)	Very useful from a lender’s perspective to see what cap rate must be to comfortably cover debt. Anchors valuation to the loan underwriting criteria: e.g. if typical bank financing is 75% LTV, 6% interest, 25-year amortization, and requires 1.25× DSCR, this formula gives the cap rate at which the property just meets those criteria. (It’s essentially the cap rate implied by the maximum loan the NOI can support). Good sanity check for lenders to ensure they aren’t lending on a property valued at too low a cap rate to cover debt service. For example, using low interest/long amortization in analysis when market has shifted could understate cap rate, as one banking veteran cautions.	Relevant mostly to lenders and debt-focused analysis. Equity investors might not care about DSCR in their pricing (they care about total return), so this is a one-sided view. Tends to produce a lower bound for cap rate (since it’s the minimum yield to not breach DSCR). Investors may demand higher yield (higher cap) than this if equity returns require it. Must update inputs with current interest rates and terms. As interest rates rise or amortization shortens, this method will indicate significantly higher cap rates – if one ignores this and keeps using last year’s number, it can lead to overvaluation in appraisal (a dangerous pitfall).

Using these methods in concert allows cross-verification. For example, you might start with market comps indicating cap rates around, say, 6–6.5%. A band-of-investment analysis using current financing and a reasonable equity yield might come out with, say, 6.8%. Meanwhile, an investor survey indicates typical cap in this segment is 6.5% and required unlevered IRRs (discount rates) around 8.5% with expected NOI growth ~2% (consistent with a 6.5% cap using Gordon model since 8.5%–2% ≈ 6.5%). In this case, all signals are in a similar zone – you might conclude ~6.5% is appropriate. If one method is an outlier, investigate why: did you use too high/low an equity yield in the band-of-investment? Is one of the sale comps not really comparable? Such differences can reveal hidden assumptions.

Importantly, ensure consistency between your cap rate and discount rate. If you decide the cap rate for year one is, say, 5%, and you expect long-term NOI growth of 3%, then using a discount rate (required IRR) of only 6% would be internally inconsistent – that would imply almost no risk premium above growth. Typically, the spread (discount minus growth) should align with the cap. Many practitioners will do a full DCF analysis as a primary valuation method, but they will cross-check the implied cap rate from that DCF. If the DCF’s implied going-in cap is far off market comp levels, they revisit the assumptions. Either the cash flow projections or the discount rate input might need adjustment. This iterative triangulation ensures the final chosen rates make sense in the context of both the income snapshot and the multi-year outlook.

To illustrate the cap–discount alignment: one industry example parsed data from an investor survey that reported going-in cap (GIC) ~6.0%, going-out cap (GOC) ~7.0%, and a discount rate ~8.5% for a given market segment. These figures imply an expected growth rate in NOI and value. Using the Gordon relation, 8.5% – 6.0% = 2.5% long-term growth. If we apply those to a cash flow model, the results were consistent with the survey’s IRR. The takeaway is that cap rates, discount rates, and growth assumptions are interlocked – triangulation leverages that fact to double-check your work.

Pitfalls to Avoid in Rate Selection

Even with the best data and methods, there are common pitfalls that can lead to misguided rate conclusions. Recognizing and avoiding these pitfalls is a crucial part of the playbook. Here we highlight a few of the most prevalent ones and how to mitigate them:

Circular Logic (Value-by-Definition): This pitfall occurs when one essentially backs into a discount rate or cap rate that justifies a predetermined value, rather than deriving it independently from market evidence. For instance, an appraiser might take the purchase price of a property and its NOI and “derive” a cap rate, then use that same cap rate to conclude the value is justified – a circular exercise offering no independent market reality check. In extreme cases, pressure from a client or deal sponsor can subtly nudge an analyst to choose a rate that makes the numbers work (e.g., lowering the discount rate until the NPV hits the contract price). This is dangerous – it undermines the credibility of the valuation and can lead to significant mispricing. As one real estate advisory put it, appraisers should be calculating, not just picking, cap rates on a whim. To avoid circular reasoning, always tie your rates to external evidence (comps, surveys, etc.) and document those links. If a client insists the property is worth $X (implicitly a certain cap rate), resist the urge to simply adopt that cap rate unless you can fully support it with market data. Transparency is key: for a DCF, show what growth rate and exit cap are implied by a chosen discount rate and check if those are realistic. If you ever find yourself “solving for the cap rate” to hit a value, pause and gather more market support or explain why the subject property might legitimately warrant a deviation. In lender contexts, independent appraisal review teams are trained to spot unsupported low cap rates – one bank advisor notes that ignoring current higher interest rates and instead using last year’s cap rate can “easily be accomplished with comps from a year and a half ago” to justify a high value, but this can set the lender up for future losses. The remedy is for reviewers to challenge such analyses and for appraisers to be forthright about market changes.
Inappropriate Comparables: Not all “comparables” are truly comparable. A frequently encountered mistake is using sales from different contexts that aren’t relevant benchmarks. For example, using cap rate data from stabilized Class A properties to value a half-leased Class B property is inappropriate unless adjustments are made. Likewise, taking national survey averages and applying them blindly to a small tertiary market asset can mislead. Another subtle example is mixing different NOI definitions – if one comp’s cap rate was based on NOI after a reserve for future capital expenses, but you apply that cap rate to a NOI before reserves, you’ll overvalue the asset. Avoid this by vetting each comp: ensure similarity in location, asset quality, lease structure, and time of sale. When differences exist, adjust qualitatively (e.g., “Subject is riskier than Comp A, so we’ll use a slightly higher cap rate than Comp A’s 5.5%”). If a comp required, say, a major lease-up after purchase, its low cap rate might reflect that upside; such a comp might actually indicate a higher stabilized cap rate if adjusted. In short, don’t be seduced by data points without context. It’s often better to narrow your data set to the 3–5 truly comparable sales than to have a dozen loosely related points. In cases of scarce data, you may rely more on surveys or analytical methods, but then clearly state why (e.g., “Only two recent sales were available, so we supplemented with regional survey figures as secondary support”). Inappropriate comps can also extend to outdated comps – which brings us to the next pitfall.
Stale Data and Market Lag: Real estate markets can shift quickly, and using out-of-date cap rate evidence is a major risk. This has been especially evident in periods of rapid interest rate movement. For instance, in 2022–2023 many markets saw borrowing costs surge, yet closed sales from 6–12 months prior reflected historically low financing costs and cap rates. An appraiser who continues to heavily weight those stale comps without adjustment will conclude a cap rate that is too low (value too high) relative to current reality. The notion of data lag is inherent in the appraisal process – by the time a sale is closed and recorded, months have passed. In volatile times, cap rate conclusions must lead the last data point, not lag it. A best practice is to time-adjust or trend older sales if you suspect market conditions have changed. For example, if interest rates are up 200 bps since comparable sales occurred, acknowledge that cap rates are likely higher now – perhaps by some fraction of that increase (not one-for-one, but directionally higher). Investor surveys and conversations with market players can help you gauge how much of a shift has occurred (“brokers say cap rates have expanded ~50–100 bps in the last two quarters for this asset class”). Stale data pitfalls also apply to investor surveys themselves – many are published quarterly, so even a survey could be a few months behind. The CBRE Cap Rate Survey report, for example, notes that while it provides a useful base, results should be viewed in context of recent events and might not reflect the latest swings. To avoid staleness, always seek the most recent data (e.g., preliminary Q3 figures instead of final Q2 if the market is moving) and be prepared to make qualitative adjustments. Lenders in particular should be wary: as one cautionary scenario described, a bank that relied on an appraisal cap rate of 6.1% based on older comps, when the market reality was closer to 10% given new interest rates, could originate a loan that is underwater on day one. The lesson: update assumptions or face potentially painful corrections.
Ignoring Asset-Specific and Micro Factors: (Related to comps selection but worth separate mention.) Sometimes analysts diligently get the “market” cap rate right, but apply it indiscriminately to the subject property’s pro forma without scrutinizing whether the NOI is reflective of stabilized market conditions. For example, if a property has some lease roll with anticipated downtime or a major upcoming capital expenditure, using a market cap rate on the current NOI will overstate value – because the NOI isn’t sustainable. One must either adjust the NOI (stabilized NOI, net of necessary capital costs) before applying the cap rate, or adjust the cap rate upward to account for the additional risk. Failure to do so is a pitfall that can be described as mismatch between rate and income. The cap rate implicitly contains assumptions about future stability; if those don’t hold for the subject, you can’t directly use the market cap. The mitigation is to always ensure you are capitalizing an income stream that matches the market’s basis. For anything not stabilized, consider performing a DCF instead of a simple direct cap, or use an “as-is” vs “stabilized” analysis where you first estimate the stabilized value (using cap rate) then deduct lease-up costs, etc.

Finally, a general safeguard against pitfalls is transparency and documentation. In professional practice, one would document the source of each input: e.g., “Selected a 7.0% cap rate based on three recent sales at 6.5%–7.0% (Table X) and a band-of-investment indicating ~7.2%. Given the subject’s slightly inferior location, we concluded towards the higher end at 7.0%. Investor survey median was 6.8%, which we considered consistent.” This kind of commentary in a report or analysis not only justifies the number but also forces the analyst to think through and avoid the above pitfalls. If you can’t write a coherent justification, that’s a red flag that you might be forcing the rate or missing something.

Lender vs. Investor Perspectives: Tailoring the Approach

Though lenders and investors look at the same property and same cash flows, their viewpoints on discount and cap rates can differ due to their roles in the capital stack and objectives. Here we outline special considerations for each:

1. The Lender’s Lens (Debt Underwriting Focus): Lenders are primarily concerned with loan repayment and downside risk. They care about cap rates insofar as it affects collateral value and the cushion between NOI and debt service. Key considerations for lenders include:

Debt Coverage and “Lender’s Cap Rate”: As discussed earlier, lenders often implicitly derive a cap rate from debt parameters. For example, using the debt coverage formula (Gettel’s formula), a bank lending at 75% LTV with a 1.25 DSCR and 6% interest amortizing might calculate: R = 0.75 0.0644 1.25 ≈ 6.04%. This ~6% would be the cap rate at which the property’s NOI just covers debt requirements. A prudent lender will compare this with the market cap rate. If market cap rates are higher (say 7%), that indicates the property value might be lower than the loan underwriting suggests (or conversely, the loan is too large for the cash flow). Loan committees often favor conservative cap rates – if an appraiser comes in with a cap rate much lower (more aggressive) than what the lender’s own DSCR analysis indicates, expect pushback. The earlier example from CCIM’s analysis showed that a lender’s simplified approach (focusing on debt cover) yielded a lower cap rate (higher value) than an investor’s required return would. In practice, many banks during underwriting will essentially cap the property’s NOI by the higher of the market cap rate or the lender’s DSCR-derived cap rate.
Emphasis on Sustainable Value (Recovery Scenarios): Lenders also consider worst-case scenarios. If the borrower defaults and the lender must foreclose, the sale is likely under distress – which often means a higher cap rate (lower price) than normal market conditions. Therefore, some lenders run a sensitivity or “stressed” valuation: e.g., “What is the value at a cap rate +50 or +100 bps above the current market, and is our loan principal covered by that?” This is effectively applying an extra risk margin to account for a forced sale scenario. For instance, if market cap is 6%, a lender might test the collateral at 7%–8% cap to see if the loan would still be within, say, 90–100% of that value. These considerations mean lenders often prefer valuations that incorporate a layer of conservatism in the cap rate. In times of rising interest rates and market uncertainty, lenders will insist appraisals reflect those higher rates – as a banking advisor noted, appraisers must not ignore rate spikes by just using outdated sales, otherwise the bank could end up lending on inflated values.
Refinancing and Loan Renewal Context: In refinancing, the lender looks at current cap rates to ensure the property’s appraised value (and thus LTV) is solid. A borrower might be refinancing a loan from 5 years ago; if cap rates have moved upward since acquisition, the lender might find the appraised value is lower than the borrower expects, limiting the refinance amount. Lenders performing internal loan reviews also need to judge if an existing loan is secured by a realistic value. A scenario described by one loan review expert involved an appraisal that “ignored the change in interest rates… and used comps from two years ago to determine the cap rate remained at 6.1%”, resulting in a valuation that made the loan look fine at 80% LTV – when in reality, using an updated ~10% cap rate, the loan was effectively over 100% LTV. Lenders must catch such issues and may condition loans on updated assumptions or even seek reappraisal if they suspect the cap rate is off.
Discount Rates for Lenders: Lenders themselves don’t typically use “discount rates” for property cash flows (that’s the equity’s domain), but they do pay attention to yield on loan and debt yield metrics. The debt yield (NOI/Loan Amount) is effectively the lender’s cap rate on their loan exposure. Many lenders have minimum debt yield requirements (e.g., won’t lend if NOI/Loan < 8% or 10%), which ties back to cap rates and leverage. Also, in some cases like construction lending or portfolio management, lenders might run scenario DCFs on the collateral to estimate their recovery under various discount rates. But generally, the discount rate concept surfaces for lenders in pricing the loan (interest rate charged) rather than valuing the property.
Communication with Appraisers: For lenders engaging appraisers, it’s important to convey any internal metrics or concerns. For instance, if a bank knows its credit committee expects a certain cap rate range for a given asset type, sharing that with the appraiser (without dictating the result) can ensure alignment. The article by Anders CPA emphasizes how appraisal reviewers and loan officers should communicate, such as informing the appraiser of typical DSC ratios or debt terms, so that the appraiser can question a cap rate that doesn’t make sense in context. Ultimately both lender and appraiser want a well-supported value conclusion.

2. The Investor’s Lens (Equity Underwriting Focus): Investors (equity buyers) are concerned with total return and upside. They use cap rates as one tool, but also heavily focus on DCF/IRR metrics. Key considerations for investors include:

Required IRR / Discount Rate by Strategy: Equity investors determine their discount rate (required IRR) based on the deal’s risk profile and the competitive landscape for capital. For example, a core real estate fund might be targeting ~6–8% IRRs (thus using discount rates in that range), while a value-add or opportunistic investor might target 12%, 15% or higher. These decisions depend on factors like leverage, business plan aggressiveness, and comparisons to other asset classes. As Altus Group notes, one starts with market benchmarks (like the risk-free Treasury rate) then layers risk premiums for property type, market, and specific risk factors. Prime assets in gateway markets have lower risk premiums (hence lower discount rates) than speculative projects in secondary markets. An investor will often cite surveys or historical deals to justify: e.g., “Our target for a stabilized apartment in a major market is an 8% unlevered IRR; this office redevelopment in a smaller city needs 12%+ to be worthwhile.” From the discount rate, the investor derives offer pricing via DCF.
Going-In vs. Stabilized vs. Exit Cap Rates: Investors differentiate between the going-in cap rate (based on Year 1 NOI at purchase), the stabilized cap rate (when the property is at steady state NOI, if it’s not initially), and the exit cap rate at sale. A common underwriting practice is to assume the exit cap rate is higher than the entry by some margin (say +50 bps) to account for potential softening in market or the aging of the property. For instance, if buying today at a 6% cap, an investor might project selling in 5 years at 6.5% or 7% cap to be conservative. This affects the discount rate indirectly (a higher exit cap lowers the sale proceeds, requiring a higher going-in yield to still hit the IRR). Investors must be careful not to be too optimistic on exit pricing – it should reflect likely market conditions and any changes in the asset’s risk profile. In competitive markets, we’ve seen some aggressive underwriting where exit cap = entry cap or even lower (assuming continued cap rate compression), but that introduces significant risk if not realized.
Using Cap Rates in Acquisition Underwriting: Investors do look at cap rates of recent comps and the market when formulating bids, but they often will accept a lower going-in cap rate if they foresee NOI growth or have a value-add plan. For example, a multifamily investor might buy at a 4% cap because they plan to renovate units and push NOI up 20%, effectively creating a higher yield on cost over time. They care more about the yield-on-cost (projected NOI after improvements / total cost) and the eventual stabilized cap. However, they will still sanity check against market cap rates: paying far below prevailing cap rates means counting on a lot of growth or assuming you can sell to an even more optimistic buyer. That’s why triangulation is key for investors too: use DCF for the heavy lifting, but ensure the implied metrics (like yield-on-cost and exit pricing) align with market norms. Many investment committees will ask, “What cap rate are we paying? What cap rate are we assuming at exit? Is that realistic given comparables and current investor sentiment?” If an underwriting requires an exit at an unprecedentedly low cap rate to achieve returns, that’s a red flag.
Equity vs Debt Perspective on Cap Rates: A fascinating difference is that an equity investor often prices in upside and accepts more risk, whereas a lender does not benefit from upside beyond getting repaid. The earlier example of Akerson (investor) vs Gettel (lender) formula results illustrated this: incorporating equity’s required return and growth (Akerson model) produced a higher cap rate (~6.86%) versus the simpler lender-focused cap (~6.04%). The ~80 bps difference was essentially the risk premium for equity beyond just covering debt. In practical terms, this means if a property’s cash flows barely cover the debt (low DSCR), a lender might still be satisfied (their needs are met), but an equity investor wouldn’t do the deal unless the price drops to raise the cap rate and yield. Equity demands more return because it’s taking first loss risk. This is why in distressed scenarios, sometimes the “investment value” to an equity buyer is considerably lower than the “loan value” a lender might have hoped – the equity needs a higher cap rate to be enticed.
Use of Surveys and Market Data by Investors: Investors also use the evidence sources we discussed. They might benchmark their underwriting discount rates and exit caps against investor surveys or broker guidance. For instance, if all peers are saying they underwrite office deals at ~8% discount rates and a given investor is at 6%, that warrants examination of whether they’re underestimating risk. Similarly, if market cap rates are say 7% but an investor is paying a 5% cap, they must justify that with either superior asset quality or growth. Often investors have in-house databases of prior deals and market intel to support their assumptions. And they typically run sensitivity analyses: e.g., “If exit cap is 0.5% higher than we think, does the deal still yield our minimum IRR?” This helps ensure they’re not caught by an adverse market move.

In summary, lenders focus on repayment risk and use cap rates to stress-test collateral value and ensure debt coverage, often resulting in a more conservative rate (higher cap, lower value) stance. Investors focus on total return, willing to accept lower initial yields if growth or repositioning will drive value, but they require a higher overall return (discount rate) commensurate with risk. Both parties ultimately rely on similar market data, but they apply different lenses: one is downside-focused, the other is opportunity-focused. Ideally, a well-structured deal finds a harmony where the investor’s pricing still provides the lender a sufficient coverage and cushion. When that isn’t the case, either the deal is re-priced or it may not be financeable.

Conclusion & Best Practices Checklist

Selecting discount and cap rates is a multifaceted exercise that blends market research, financial theory, and practical judgment. By using a structured approach – gathering diverse evidence, triangulating with multiple methods, and avoiding common missteps – analysts can arrive at well-supported rates that stand up to scrutiny from investment committees or credit reviewers.

For a closing takeaway, here’s a quick playbook checklist of actionable best practices when determining cap and discount rates in CRE:

Gather Current Market Evidence: Collect at least one primary data point (recent comparable sale cap rates) and multiple secondary sources (latest investor survey data, broker quotes, etc.). Ensure data is as recent as possible to capture current conditions. Document these findings in a table or appendix for transparency.
Segment and Compare: Align your evidence to the subject property’s profile – compare apples to apples. Adjust or weight data based on property class, location, and stability. Recognize when you have to rely on broader benchmarks (and note their limitations).
Apply Multiple Valuation Methods: Don’t rely on a single approach. Compute a band-of-investment cap rate using realistic debt/equity inputs. Run a quick DCF or Gordon Model check to link your cap and growth assumptions. If you’re a lender, calculate the implied cap from your DSCR constraints and see how it stacks up. Triangulate these results – if they generally converge, you gain confidence; if not, investigate the divergences.
Sense-Check with Logic and Experience: Does the implied risk premium make sense given risk-free rates and the asset’s risk? (E.g., “We’re assuming a 8% discount rate while 10-year Treasuries are 4%; is a 400 bps spread adequate for this asset’s risk?”). Is the cap rate reasonable relative to other assets? (E.g., if apartments are 5% and typically office is +200 bps, is our office cap around 7%? If not, why are we deviating?)
Avoid Pitfalls Proactively: Ensure you are not reverse-engineering the rate to “make the deal work” – ground it in market support to avoid circular justification. Scrutinize each comp – throw out or adjust those that don’t fit. Update all data for current market sentiment; don’t let old info linger unadjusted. Use sensitivity analysis to check how outcomes change if your rate is off by, say, 50 bps (better to know the impact upfront).
Differentiate Lender/Investor Requirements: If you’re advising both equity and debt stakeholders, be clear about how perspectives differ. Maybe present two analyses: one showing the investment value range (equity view) and one the mortgage lending value (debt view). Reconcile the two – if a gap exists, that’s where negotiation or structure comes in (e.g., more equity to reduce loan risk, etc.). Use frameworks like the Gettel vs. Akerson formulas to explain these differences in meetings.
Document and Justify: Finally, articulate your concluded cap rate and discount rate with a concise rationale. For example: “Concluded a 6.25% cap rate for the subject, supported by three local sales at 6–6.5% (adjusted downward slightly for the subject’s newer construction). Band-of-investment analysis with 65% debt at 5% interest and 10% equity yield gave 6.3%, corroborating our conclusion. Using a growth rate of 2%, the implied discount rate is ~8.25%, in line with investor survey averages for this asset class.” This level of reasoning not only strengthens the credibility of the analysis but also provides a record that can be revisited if market conditions change.

By adhering to this playbook, lenders and investors can navigate the complex task of rate selection with greater confidence. The outcome is a more robust valuation/underwriting that withstands market reality checks and fluctuating economic winds. In a dynamic U.S. commercial real estate environment, such rigor is not just advisable – it is essential for sound decision-making and risk management. Armed with the right data, methods, and mindset, one can demystify discount rates and cap rates and use them as effective tools to allocate capital wisely and gauge investment performance.

October 20, 2025, by a collective authors of MMCG Invest, LLC, real estate feasibility study consultants.

Sources:

PwC Real Estate Investor Survey (formerly Korpacz Survey), Q2–Q3 2025.
CBRE Cap Rate Survey, 2025 Mid-Year Report.
NCREIF Property Index (NPI) – Historical institutional property performance data.
Appraisal Institute, The Appraisal of Real Estate (15th Edition).
CCIM Institute Journal – “Band of Investment and Mortgage-Equity Capitalization Revisited.”
Altus Group, Valuation Fundamentals: Discount and Capitalization Rate Selection (Insight Series, 2024).
Anders CPA Advisors, “Why Appraisers Must Reflect Rising Interest Rates” (2023).
Federal Reserve Economic Data (FRED) – Treasury yields and market risk-free benchmarks.