Cap rates do not apply to SFH. Use cash on cash and IRR if you can make any reasonable assumptions about your exit price.
@Nick B. Thanks, that's helpful. Can you tell me what most investors look as a criteria to meet? The SFR I'm looking at are 11-21% COC 1st year and 19-30% IRR. I know it will depend on markets.
@Amanda N. , you are the only one who can decide what ROI is acceptable for you.
Personally, I am looking for at least 8% cash-on-cash and 17% IRR in syndicated apartment deals. I don't invest in SFH, so no criteria there.
Cap rates do apply to SFRs, while maybe not technically....they are used, often, and are fine and great to use for reference. However, cash-on-cash if you are financing will always be more accurate and the only thing that matters. The cap rate, if you are financing, is just really telling you a mysterious number that doesn't actually apply directly to your return. It just suggests whether you are getting a decent deal or not in relation to the market. The cash-on-cash is what tells you the actual return you'll be getting on your money.
In some cases the CoC will be significantly higher than the cap rate, sometimes significantly lower. So you want to know that, for sure. I've seen low CoCs be deal-breakers on properties that otherwise showed a good cap rate.
I'm also in CA and have always bought turnkeys.... I'd be curious on the A neighborhood properties that are cash-flowing. Typically A neighborhoods and A properties won't cash flow, so it usually requires going just a smidge lower in quality to see that. But if there are A cash-flowers out there, I'd be curious to check them out myself if you don't mind sharing.
Agree with @Nick B.
Cap rate is a "valuation" metric and is a component of the income approach to property valuation. It applies only to commercial properties because commercial properties are valued by their income. It does not apply to SFRs because SFRs are valued using sales of recently sold comparables.
Some investors insist on using Cap Rate as a "performance" metric to compare and contrast competing investment opportunities. As a performance metric Cap Rate is just flawed and there are other much better metrics (i.e. CoC, IRR). I would follow @Nick B. 's advice.
Difference between Cap Rate and CoC??
- Cap Rate is property specific metric, while CoC is investor specific metric (i.e. regardless of whether or not financing is used).
- Cap Rate = CoC when Financing = 0
- If you don't finance a property CoC = Cap Rate. If you finance a property CoC is a better metric than Cap Rate. So why use Cap Rate at all then? Why not use CoC exclusively?
Create Lasting Wealth Through Real Estate
Join the millions of people achieving financial freedom through the power of real estate investing