What do you think is a "good enough" cap rate?

Question

When interest rates were much higher, we only looked at places with a 10+ cap rate. Now that interest rates are so low, properties cash flow with a lower cap rate than in the past, leaving more wiggle room in pricing. We wrote an offer today on a turn-key rental property in a B+ neighborhood with a 7.5 cap. My last property had a 11 cap. I know in the Bay Area we see more like 5% cap rates. Side note: In what cities are you seeing the BEST cap rates?

Greg Scott · Answer

Frankly, I don't focus on cap rate.

In single family, the cap rate is an irrelevant metric because it has no bearing on value, so I focus on cash-on-cash return.

In apartments cap rate is not my critical metric, but it helps identify which properties might be more interesting.  Of course as interest rates come down, lower cap rates become much more attractive.  Instead of cap rate,  I focus on total returns to investors and DSCR-limited investment proceed .

Brian Garlington · Answer

As another poster said..............Cap rate and small residential multifamily or SFRs do not belong in the same sentence. If you are trying to get positive cashflow in a house in a B+ neighborhood in the Bay Area it will be impossible in this market.

Russell Brazil · Answer

There is no such thing as a good or bad cap rate.

Cap rates are a reflection of the perceived risk in the asset, asset class and market. Neither low or high mean good or bad, just varying degrees of risk.

Greg Scott · Answer

Well said.

I have no idea why BP shows Cap Rate in their single family rental calculator.  It's like asking how many yards per carry a baseball team had last year.  Irrelevant.

Frank Rodrigues · Answer

Cap rates will change depending on demographic classes and areas across the country. For example, the KC market for SFH will generally yield around 10%, in Cleveland around 12% on average. In both markets multi's will be a bit higher. COC returns for both are double digits as well from my experience as well. Ultimately it's about your goals and what kind of profit YOU are looking to gain from properties in the short or long run.

Seth Young · Answer

Cap rate is a confusing number for SFH. I would say cash on cash or total ROI is a better indicator for the potential of your investment in a SFH.

Anthony Angotti · Answer

I agree with those posting that on single family and 2-4 unit multifamily cap rate is irrelevant.

Its a metric for commercial real estate to value assets.

Additionally it's based on NOI so it doesn't factor in leverage at all. It can be useful to know and to compare assets but it's not the highest on my list of something I look at as a cutoff number. Also as someone with employees and my own team I'm not looking at cap rate for any idea of what my buildings will return. I am only looking at it for what the building will appraise at or sell when refinancing or selling my commercial buildings.

Im generally looking at my long term IRR on a building and if I can get all of my cash out at some point before I even consider cap rate. Of course it plays into that because it dictates what I can refinance my commercial buildings at, but I'm looking at the area for that rather than an individual buildings.

I look at what the NOI is now and what I can get it to. Then value the property based on what the project is worth to me. Which is generally returning the bulk of my invested capital back to me and having a healthy NOI on the back end.

At no point do I care what the cap rate is at purchase other than for the area that it is in. It's all cost of my project and what I can get out of it after I finish the project.

Cap rate only matters to me if buying a fully turnkey commercial building or something that requires little to no capital improvements. Then I guess 8% or higher, but the type of financing I'm using is still important. If I'm no cash out of pocket then I'd take a lower cap. If I'm more cash out of pocket I want it to be higher.

Raju Balakrishnan · Answer

Cap rate is one of the metric which helps, but a good cap rate depends on several other factors, most of all upside. Growing markets and areas tends to have lower cap rates, same with properties with upside by rent increase of by improvements. As Grant Cardon mentions in one of his books, low cap rate properties are most promising in a market generally, if you can afford it. They come with upside but with higher down payment and upfront cash requirements.

Jennifer Jo McCallon · Answer

I guess I should mention I generally don't buy SFHs. The cap was the go-to metric 15 years ago when I started investing, now it seems way more factors come into play, such as appreciation, quality of the property (I bought something with a 22% cap in Braddock PA last year, but also the wind could blow it over at any minute...), and estimated future value increases.  Happy to be here and learn and grow! Thanks all.

Shelley L. Reynolds · Answer

I try to stay north of 13% but yes it really does depend on the market.

What do you think is a "good enough" cap rate?

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