Explanation of cap rate

[Rickey Davis]

What exactly is cap rate and how is it determined? What’s good or bad in terms of cap rate?

[Aaron K.]

good or bad depends on location and quality.  Cap rate is calculated as income - expenses (excluding debt service) divided by purchase price

[Joshua Tessier]

Divide the net income by the property's purchase price.

[Immanuel Sibero]

@Rickey Davis

There are mostly two ways cap rate is viewed on BP. One is the view that cap rate is a "property" related measure of performance - in a particular property, the higher the cap rate the better the property. The other is the view that cap rate is "market" related measure of value vs risk in a particular market (i.e. general investor sentiments towards that market) - the lower the cap rate the lower the risk and the higher the value.

Most investors, particularly newbies, especially those active in residential assets use the term cap rate to refer to the performance of a property, so they're always looking for the best, or the highest cap rate. Whereas investors who deal with commercial assets use the term cap rate to refer to the value vs risk trade off of a certain commercial properties so they're not looking for highest or best cap rate. As a matter of fact some of the best commercial assets are in markets with very low cap rate. In commercial real estate, there is no such thing as the best or highest cap rate.

Cheers... Immanuel

[Rickey Davis]

Thanks a lot guys for this valuable information. 

[Alina Trigub]

@Rickey Davis

Cap Rate allows you to get a sense of the initial investment worthiness. However it by no means should looked at in vacuum. You have to evaluate it along with many other indicators. Here's an article detailing it further: 

https://www.biggerpockets.com/member-blogs/10850/79257-deciphering-syndication-investment-terminology

[Rickey Davis]

Thanks a lot for the info Alina

[Wendy S.]

@Alina Trigub

Thanks Alina for the link to these simplified and easy to follow terms and calculations.