Cap Rate vs Discount Rate: How They Differ and When to Use Each
By Devon Coombs, CPA, MBA · Teaching Professor of Finance, Santa Clara University · Reviewed August 2026
Use a cap rate to convert a single stabilized year of NOI into value, and use a discount rate to bring a multi-year cash flow stream to present value in a DCF. The two are linked rather than interchangeable, because for steadily growing income the cap rate approximately equals the discount rate minus expected growth (R = Y minus g). A property with a 10 percent required return and 3 percent expected growth should therefore trade near a 7 percent cap rate.
| Cap rate | Discount rate | |
|---|---|---|
| Definition | Year-one NOI divided by value | Required total return used to discount future cash flows |
| Applies to | A single representative year | Every projected cash flow, including the reversion |
| Growth | Embedded implicitly; expected growth compresses it | Handled explicitly in the projected cash flows |
| Source | Extracted from comparable sales | Risk-free rate plus risk premia, or investor surveys |
| Relationship | R is approximately Y minus g | Y is approximately R plus g |
| Typical level | Below the discount rate when growth is expected | Above the cap rate by roughly expected growth |
When Cap rate is the right tool
Reach for the cap rate when pricing or quoting a stabilized property, because it is directly observable from comparable sales and compresses the market's growth and risk expectations into one number. It is the right divisor in direct capitalization and the natural way to express a purchase price or an exit value. Using it as a discount rate on growing income overstates value, because the cap rate is a required return with expected growth already netted out.
When Discount rate is the right tool
Use the discount rate inside any DCF, on both the annual cash flows and the reversion, because it represents the total return an investor requires for the risk and timing of that stream. It is typically built from the risk-free rate plus a real estate risk premium and property-specific adjustments, and it generally sits above the cap rate by roughly the expected growth rate. A quick check on any DCF is whether the implied going-in cap rate and the discount rate differ by a growth assumption the market would recognize.
The common mistake
The classic error is plugging one rate in where the other belongs. Discounting a growing NOI stream at the cap rate overstates value, because expected growth is then counted twice, once in the projected cash flows and once inside the rate. Capitalizing NOI at the full discount rate understates value by implicitly denying the property any growth. The spread between the two rates is the market's growth expectation, so a valuation that pairs a 7 percent cap rate with a 7 percent discount rate is forecasting zero growth and should defend that choice explicitly.
Work the numbers yourself
Both concepts are taught in depth, with practice questions, in the free Real Estate Finance course.