I'm new to the REI world and still learning the basics. Something I'm trying to wrap my head around is whether the cap rate is actually a reliable indicator of the risk of an investment. My understanding is that the metric itself is simply the ratio of NOI and cash purchase price, and a higher cap rate generally indicates more risk.
However, it seems like there are so many factors that could artificially inflate/deflate the cap rate for a particular property. For example, let's say I find a MFH for sale and successfully negotiate the price down by 20% (probably a great deal!). My cap rate just increased by 25%, but certainly my risk did not change? I can imagine that if you look at large markets over time, these effects average out and you can get some snapshot of the risk in that market. But when looking at the cap rate of an individual property, I am having a hard time trusting the usefulness of the metric.
Similarly, there are so many factors that I would think influence the actual risk of an individual property. Things like age, condition, location, financing conditions, etc. All these considerations are lost information when looking at individual cap rates. Yet it seems like such a commonly used/talked about metric.
Anyone have any insight? Anyone know of any studies that have looked at the relationship between the observed cap rate of a large group of properties and their actual investment performances to see if cap rates actually correlate with risk/performance on an individual basis?
