What does the cap rate mean?

Any help would be appreciated. A while ago I came across a posting on this board stating that the higher the cap rate, the better in multifamily investment property. What exactly is the cap rate and what does it mean? What is a “good” or desirable cap rate to have?


Howdy Shsugrad:

Cap rate is short for capitalization rate. It is the ratio of net income to the asking price or value of the property.

Net Income / value = Cap rate

A property with $10,000 per year income after expenses ( not income Tax) would be worth $100,000 with a cap rate of 10. The same property would have a cap rate of 8.3 if the value were $120,000.

Different types of property demand different cap rates. A property with less risk and work would have a lower cap rate. A Wallmart building for instance with a Triple Net lease would fetch a higher price and lower cap rate than a mobile home park or low income apartment house. With interest rates at all time lows cap rates have fallen as well driving up the values.

I hope this helps. LOL

i dont know the science of it. i sucks at Math.

but i care is, if it doesnt have cap rate of 9% or more… i move on. unless it is a single family. then cap rates are loiwer

If you’re looking for an easy way to think of the cap rate, it tells you how much money (net of expenses) you get back after the first 12 months of ownership if you paid all cash.

It’s the same as a cash on cash return if you are not using debt.

If you’re looking into getting started with commercial RE, you really need to take time educate yourself. CAP rate, Cash on Cash Return, GOI, NOI, etc…are the part of the basic terms that you need learn.

There are a number of great books in Amazon (http://tinyurl.com/9vqncoo) and cheap too, that will help give you a good foundation of knowledge.

Here’s a simple way to grasp CAP rates…

We ask ourselves, "What would the percentage of return be on an all cash purchase?

To determine the return, we take the total cash flow, before debt service, and divide that sum by the sale price (assuming it was an all-cash purchase).

For example, if the project pushed off $100,000 in cash-flow (before debt service), and the all-cash price was $1,500,000, we would divide that $100,000 by $1,500,000 and come up with 6.6% total return on an all-cash purchase …or a 6.6% CAP Rate.

CAP Rate is short for capitalization rate. One definition might include the percentage of return, at a given sale price, without using leverage (without borrowing to buy).

It’s a starting place for evaluating market value, if not the profitability of a given deal.

However, CAP rates don’t really tell us what the return will be, unless we ARE paying all cash …and it assumes that the income and expense numbers are accurate.

Otherwise, the price and net cash flow are both used to determine a CAP rate, and then that rate is compared to the market cap of similar properties in the area.