Risk-Free Rate

The risk-free rate is what an investment pays when default is practically impossible, and most analysts use the yield on US Treasury securities for it. Cap rates are often described as the risk-free rate plus a premium for the risk and illiquidity of owning property, minus expected growth.

Commercial analysts track the spread between cap rates and the 10-year Treasury yield. A wide spread suggests property is cheap relative to bonds; a narrow one suggests the opposite. The spread moves over time, so cap rates do not follow Treasury yields point for point.

For a single rental, the practical use is as a floor. A cap rate below the risk-free rate means the property earns less today than a government bond, and the buyer is counting entirely on rent growth or appreciation to make up the difference.