What is minimum for good cap rate on a rental property?

[Reggie Desir]

New to the rental property investing game and I’m just trying to determine criteria to analyze deals more efficiently. What should be my baseline for cap rate on a rental property? The areas I’m focusing on investing in are Providence Rhode Island, Worcester and Fall River Massachusetts. Thanks in advance

[Spencer Gray]

Someone more snarky than me might say "there's no such thing as a "good" cap rate, cap rates have nothing to do with return." So while the first part is technically true, we all know what you're asking and are looking for. 

The best way to answer your question is to network some local investors/brokers/lenders and see what they are seeing/buying. That will give you a good sense of the market. It's not so much that you pick a target cap rate and you find a property to match. Instead, learn the market cap rate range, and see if that aligns with your risk tolerance and works with your strategy. You may decide you'll need to move up on the risk curve to get the return/cap rate that you're looking for. But still don't judge a deal just on cap rate alone. 

 A property purchased at a 3% cap rate can have a significantly higher cash on cash and total return than a property purchased at an 8% cap rate. The opposite can also, and often is, true. 

If you buy a 5 unit that is 40% occupied, at a 3% cap, but you are able to lease up the other 3 units at significantly higher rents, raise rents on the two renewals, you could be operating at a 7-8% yield on cost (or cap rate), with a 10%-+ cash on cash return. These are rough numbers, not exact.

Buy at an ~8% cap rate, but two tenants disappear after destroying their units. Now you could be operating at a 4% yield on cost, or worse.

Higher cap rate = higher risk low investor demand. Lower cap rate = lower risk higher investor demand. 

In a perfect market risk = return.

Now the trick is to identify where the market is inefficient at pricing risk, and exploit it. However to do that, you do need to know your baselines, how to operate, and be confident in your execution. 

Best of luck!