what is a good cap rate?

6 Replies

Really good.... 12% and up. Decent.... 7% - 12%. Not good, less than 7%. Yes, CAP rate is very important when analyzing commercial multi family properties

Short answer:

=>10,7 to 8,=<5

Winded one:

There is a lot to consider when talking about cap rates. First the cap rate on a property is only created once your offer is accepted. With that said you want the highest cap rate possible the seller wants the lowest. 

Cap rates change in every market and even sub markets. So the first thing to know is what the "average" cap rate is. Be careful though. I'm from a small area and cap rates in town or what one would consider the business district is 2 points lower than just outside of town. Still the same zip code but slightly outside the "place to be".

With that being said it really comes down to what you are willing to accept as your return on the capital you deployed. 

I am in the wealth creation portion of my life's plan so I am looking for cap rates well above what I will pay in interest on my debt. Having a nice spread between your return and your interest rate also serves as "insurance" when the interest rates go up. Most commercial loans are adjustable over a certain period of time. 

When I analyze deals I pay much more attention to my cash flow number.  Cash is king and when the market falls out from under you your cash flow is what will get you through.

A "good" cap rate is a really broad measure as it is market specific as well as asset class specific. Certain parts of the country are used to 8-10 cap deals...here in Denver we get excited for a 6 cap. We buy SFR for a big company that will take a 5 cap.

This is a very important concept to understand. Based on the general nature that you're asking the question, I would recommend that you read up on it, https://www.propertymetrics.com/blog/2013/06/03/ca... is a good place to start. Also search in this forum, there are a lot of good questions/answers regarding cap rate.

Also, it is one thing to know how to calculate it, it is another thing entirely to know how it impacts your purchase price, sale price and the overall returns you can expect on an investment. While I agree with the general sentiment that cash is king and you should make sure that you have cash flowing properties, not paying attention to the cap rate when you buy and overpaying can cost you dearly in a market down cycle if you want to sell or need to sell when a note comes due.

Lower caps aren’t a bad thing unless the market has no projected growth. Comparing cap rates in different markets or sub markets is a fools errand. I’d buy a 5 cap value add deal any day of the week in a growing market with the prospect of jobs over a 12 cap in a depressed area.

@Arturo Borges Hey Arturo, a good cap rate is relative and market-specific. In addition, it is also helpful to understand your investor cohort and what they are looking to do with their capital. 

Some investors are looking to hedge their capital against inflation (park their money), and they do not mind investing a somewhat low cap rate of say 5% in NYC, while others are expecting at least a 12 cap in other markets. 

To conclude, if you analyse about 100 buildings in your market, which is what I did, the going cap rate will scream at youIt would be so obvious to you at the end of that exercise

Hope this helps, Arturo. Goodluck. Thanks! - Ola