Can somebody please explain cap rates for me?

[German E Franco]

Hi BP community! I was wondering if somebody could please explain cap rates for me? I’ve watched videos and read articles but I can’t seem to understand

How do you calculate them?

When do they matter?

Thank you!

[Russell Brazil]

Cap rate is calculated by dividing the NOI, Net Operating Income (Thats Gross income, minus operating expenses) by the value of the property.

Lets say you have $20k in gross rents, and $10k in operating expenses, that leaves $10k in NOI. Lets just say the properties value is $100k. $10k/$100k=10% Cap Rate.

Are you familiar with Bond Investing at all? Understanding cap rates is akin to understanding bond investing.  Whats generally considered the safest bond out there? Short term US Treasury bonds.....and to account for that safety they also have the lowest yields on them.  Then the longer the bond is dated, 2 years, 10 years, 30 years, the higher the interest rate then becomes on those bonds to correspond with the higher and higher risk at each years intervals. Then corporate junk bonds have even higher yields and interest rates.

The same thing happens with real estate.  Really low risk assets, like a Class A office building in Downtown DC will have really low cap rates.....and some Class D Apartment building in say Detroit would have a really high cap rate, each with their cap rates being a reflection of the risk in the asset and market you are investing.