Cap rate how important is it to you and how do you use it?

Question

What cap rate do you look for when analysing a property? Do you stick by the same percent for each investment? Is there a "best" cap rate?

John Warren · Answer

@Dimitry Peters I am less concerned about what the cap rate is when I buy the property, and more concerned with what the cap rate will be when I am operating the property. Typically, I buy things that are value add so the cap rates are very low (3, 4 or 5 even). Once I take over, I get them operating at a 10 cap or even higher.

In the Chicago burbs where I invest, it seems that the going cap rate for "stabilized" multifamily is anywhere from 4 cap in the A areas to 6-7 cap in the C areas. Even then, when you dig into the number a lot of the deals listed by local commercial brokers are actually probably negative cap rates.

Ryan Webster · Answer

@Dimitry Peters

Cap rate is a important metric. It is a measure of an investments return, a properties value, and the market in which a invesement is located. A complete understanding of cap rates can tell you alot.

If you are investing in multifamly ( 4 units and above) cap rate will determine appraisal, future appreciation, how easily you can exit, and how much your bank will lend you.

When looking at a markets average cap rate you can determine if there is high demand for your particular asset class in a market. The lower the cap rate the higher the prices, and higher the demand in that market. This will help you with your exit when you go to sell the property. Not only will finding a buyer be easier in a high demand market but your chances of appreciation are greater especially if you can get into a market that has strong economic indicators where cap rate are compressing or trending down.

Forced appreciation is also calculated using market cap rates. The formula is as follows any increase to the noi devided by the market cap rate equals appriciated value.

It is very important to understand cap rates I'm your market. Whether they are flat, going up, or going down. Cap rates are a very simplistic value used to measure the much more complicated and diverse economic eco system in each market

They allow us to quickly and easily asses the health and condition of a local investment economy, and more accurately predict the future returns on our investments.

Crystal Smith · Answer

We use CAP RATE to compare investments. For properties where we do not have to add value, we'll look at a Performa but won't commit without actuals. If it's a value add we'll run own numbers to determine if we can hit our CAP Rate target. There is no "best" cap. The best cap is what you expect for a return on investment.

Taylor L. · Answer

Cap rate is low on my list of criteria. I'd rather know about the metrics that relate to what our business plan will produce - cash on cash return, equity multiple, IRR, and other such similar metrics. We plan on our reversion cap rates to be higher than acquisition, of course.

Calvin Ozanick · Answer

@Ryan Webster said it all. I will not go into detail like that, however, I will tell you that cap rate is not the only metric to pursue. Many people purchase based on Cash on Cash ROI. Other investors aim strictly for cash flow. Be sure you look at your own real estate plan and to evaluate what you are most looking for. Best of luck along the way.

Bob Floss II · Answer

@Dimitry Peters I love using CAP rate for determining the value and negotiating on a property. First, it's important to know a good CAP for the property area. An 8 CAP might look good until you realize the neighborhood has rent collection problems and most investors won't go under a 10 CAP. You might also look past a 6 CAP as not profitable enough, but the neighborhood and building may very easy to manage and there's potential to increase rent or decrease expenses. Second, once you know the CAP rate you want to hit, pour over the income and expense sheets. I can't tell you how many times we initiate attorney review and the rent rolls and/or expenses were a figment of their imagination. When we get actual numbers, we go back and reflect that in the CAP and sometimes have to renegotiate deals.

Jaron Walling · Answer

@Ryan Webster Great explanation of Cap Rates. Thank you for sharing the knowledge.

Cap rate how important is it to you and how do you use it?

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