Let me show you two deals. A Walgreens at an 8.1% cap rate, and a Chick-fil-A at a 4.45% cap rate. Both triple net. Both corporate tenants. Roughly the same lease.
The instinct is to look at that Walgreens and go, "Well, that's obviously the better deal. Bigger yield, big-name tenant, almost double the return." And that instinct is exactly how investors get burned.
Because a high cap rate is not a reward. It's a price tag on risk. So let me walk you through what a cap rate is actually pricing, and the four questions I ask before I'll touch a high-cap-rate deal.
In This Article
What a Cap Rate Actually Prices
The Same Logic for Strip Centers
The Danger Pay, By the Numbers
8.1%
Walgreens cap rate, the "better" deal that isn't
4.45%
Chick-fil-A cap rate, lower price, lower risk
6.6%
Average U.S. retail cap rate, per the Boulder Group
What a Cap Rate Actually Prices
Here's the thing most people miss: price and risk sit on the same seesaw. They can't move separately. As risk goes up, price comes down. As price goes up, risk comes down. The cap rate is just the market's way of pricing the risk in a deal.
So when you sort LoopNet or Crexi by cap rate and the 8% reads as a better deal than the 4.45%, that's where the trap starts. You're not looking at a better return. You're looking at a riskier one.
Ask yourself this: if the person who owns that Walgreens could sell it at a 6% cap rate, don't you think they would? Of course they would. The fact that it's priced at an 8.1% cap means the market knows something, about the tenant, the lease, the building, or the location.
For context, average retail cap rates right now sit around 6.6%, according to the Boulder Group. Chick-fil-A and McDonald's are neck and neck near 4.45%. CVS is around 5.74%. Walgreens is at 8.1%. Family Dollar is at 8.75%. Every point above that average is the market pricing in more risk. I call that gap the danger pay.
The Four Questions I Ask Before Any Cap Rate Deal
When you're staring at a triple net deal with a juicy cap rate, run it through these four questions before you get excited.
1. Who Actually Signed the Lease?
A corporate signature feels like a bond. It is not. Not necessarily. You can have two identical buildings, identical rents, identical NNN leases, and the price someone will pay for a Starbucks corporate guarantee versus a startup on its very first location is night and day.
Walgreens used to have a trophy-tier guarantee. Not anymore. They're private-equity owned now, they went private, and they're leveraged. Remember, Macy's and Sears had strong corporate guarantees once too. A guarantee is not permanent. You have to dig into who's really standing behind that lease today, not five years ago. That's exactly the kind of tenant credit work that belongs in your due diligence.
2. What Is the Sector Doing?
Don't just look at the tenant. Look at their whole category. Is it opening stores or closing them?
Chick-fil-A is still opening locations and posting the best per-store sales in the sector. Walgreens is closing stores every year. Whataburger and In-N-Out are expanding across the Southeast. How many new pharmacies have you seen open lately? A tenant in a shrinking category is a completely different risk than the same tenant in a growing one, even with the same lease on paper.
3. How Much Term Is Left?
Same lease, same building. But 18 years of remaining term versus 4 years are entirely different planets.
If a tenant only has two, three, or four years left, you're not really buying income anymore. You're buying a building that happens to be paying you today and won't be tomorrow. Honestly, at that point it probably shouldn't even trade on a cap rate. You need to know what that box is worth empty, not full, and whether the rent is close to market.
4. What's the Rent Versus Market?
Above-market rent means your yield evaporates at renewal. It's common on brand-new single tenant net lease deals where the tenant is paying 10, 20, even 30% over market because the landlord baked the build-out and the FF&E back into the rent.
That's fine if you've got 15 years of high-credit term and you'll collect it long enough to win. But if you have to take that box back and re-lease it, the next tenant is paying market or below. Model the deal as if that day is coming, because eventually it is.
The Empty Box Test (And Why I'm Wary of Dollar General)
Here's the single most important question underneath all of this: what is that box worth empty?
For a Chick-fil-A, the corner is worth most of the price. Even if they ever left, which I've rarely seen, it's a good enough location to backfill with another quick-service restaurant. A Walgreens is a different beast. Those buildings and parking layouts aren't always easy to convert, and CVS usually doesn't want to move into a building that screams "Walgreens." So now you're really just buying the land.
This is why I'm not a fan of most Dollar Generals. They sign 15-year leases, but on average they only stay about 17 years total, which gives you roughly a 40% chance they renew. And they love to build a brand-new store across the street rather than renew. Worse, they're often in the middle of nowhere. I drove past one on a farm road in Kentucky with my wife recently and thought, "When that Dollar General leaves, nobody is ever filling that building again."
"In Chapter 11, a lease is not a guarantee. It's a suggestion. Rite Aid rejected 168 corporate-guaranteed leases in bankruptcy, and those landlords had guarantees too."
- Tyler Cauble
The Same Logic Applies to Strip Centers
Most of us aren't buying single tenant net lease deals anyway. Those are the bonds of commercial real estate. They make sense in a 1031 exchange or when you just want secure cash flow and no headaches, but you're not getting rich on them.
The same report card applies to a three-tenant strip center at an 8% cap. Now your credit is a local LLC. The nail salon's personal guarantee is your corporate signature, so grade it the same way. Your term is three to five years, not fifteen, so rollover risk shows up on your rent roll every year. And you have to price in the tenant improvements, the downtime, the leasing commissions, and the attorney's fees every time a tenant turns.
The one advantage: with three tenants, one vacancy is a 33% haircut, not 100%. But run your dark test. Lose one tenant and that 8% cap can drop to a 5.3%, and you might not be breaking even anymore.
So Is a High Cap Rate Good?
Yes, a high cap rate can be a great deal. It's fine to accept the danger pay. I'll happily look at an 8, 9, even 10% cap rate. We've looked at 12% cap deals, and a 12 usually means the risk is enormous or something is wrong with the property. But I'm fine with all of it, as long as I know going in exactly what I'm being paid to take on.
The trap isn't the high cap rate. The trap is treating an 8% cap deal like it's a 4% cap deal. It's assuming three five-year leases with local tenants means five worry-free years, when any one of them could go dark next quarter.
So analyze it conservatively. We're not underwriting to see if a deal is good. We're underwriting to see if it's not bad. All it takes is one bad deal to sink you, and there are dozens of good ones out there. If a seller won't accept realistic expenses and risk, let them hold it a few more years. Let it be their problem, not yours.
Key Takeaways
A cap rate prices risk, not reward. A higher yield means the market sees more risk, period.
Run the four questions: who signed the lease, what the sector's doing, how much term is left, and rent versus market.
Know what the box is worth empty. That's the real floor on your downside.
A corporate guarantee isn't a bond. In bankruptcy, a lease is just a suggestion.
High cap rates are fine, if you price the risk honestly and you'd happily run the re-lease play yourself.
This article is adapted from an Office Hours livestream on the Tyler Cauble YouTube channel.
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