What You Need To Know About Cap Rates When Investing

[Justin Goodin]

There are many data points that are far more important than cap rates, especially for passive investors. The track record of the sponsorship team on a real estate syndication investment should be the top thing you look at.

Otherwise, cap rate might carry weight in these two arenas:

#1 – Is the cap rate comparable to other assets in the area?

A strong sponsor team will have already evaluated the property to ensure the cap rate is comparable to others in the area, but you could double-check that your property isn't’ 4% while others are 7%.

#2 – What’s the reversion cap rate?

Here’s one that might throw you for a loop - Reversion Cap Rate.

Sometimes the cap rate is referred to as the exit cap rate because the reversion cap rate is a measure of the cap rate at the sale of the asset, versus the cap rate at the time you purchased the asset.

If nothing else, take this knowledge with you- When evaluating a potential real estate syndication deal, be sure the reversion cap rate is at least 0.5% HIGHER than the current cap rate.

This means that the sponsors believe the property/ market conditions will be WORSE than it is now. In other words, they assume things will be in worse condition than they are now and that the property will sell for a lower price.

If the current cap rate is 5%, then the reversion cap rate should be at least 5.5%. That will be a great indicator of conservative underwriting and that projections include the possibility of the market softening in upcoming years.

Cap Rates - All Said And Done

At the end of the day, cap rate is a single measurement at a single point in time, based on the current performance of a given property. Cap rates don’t measure the potential of an asset or how much you’ll receive in distributions.

You definitely want to know what things mean and be on the look for this terminology while choosing an investment. Beyond that, you will find that cap rates are one of the last things to be concerned about when picking the right investment.