I have a few questions about cap rate while studying about commercial real estate
What is an example of the same cap rate being good in one scenario vs bad in another?

How to know if a commercial property is a good investment?

How does current market cap rate affect pricing in the area?

Using my previous hostel business or house, how does it compare to a commercial investment? (My house was worth $250,000 with a mortgage of 1.3k and gross income per month was around 10K with expenses being around 40%, so cap rate in this case would be around 20%, is that not a good investment?

How is cap rate affected by income vs property price?

How can the same property have different cap rates based on the city that it's in?

If income is greater then cap rate rises, does this mean a higher cap rate is a better investment because of higher returns?

How does federal interest rate affect commercial property cap rate?

What does it mean if San Francisco cap rate is lower than average national cap rate?

If cap rate is how much you earn, why not just call it yield rate?
[{"id": "i4tfxd0", "text": "Cap rate is mostly just a measure of comparison when looking at retail properties in my work. For example, if a certain NNN tenant outparcel sells for 5% cap rate, I know I can get similar cap rate on development of that tenant assuming similar lease structure and location. It shouldn\u2019t be used as a measure of return but can tell you how investors are valuing different properties. If you look at the mall industry some of those cap rates are in the excess of 20% because cap rates are supposed to measure stabilized income, which most malls do not have these day.", "replies": [{"id": "i4tsc02", "text": "May not be the most formal definition but cap rates to me seem to be a gauge of how much risk an asset carries. The higher the cap rate the more unstable the property, or the less upside from appreciation on that land. An industrial site in rural Alabama could have a steady tenant but not much upside co it may carry a 9% cap, but a Starbucks in a stable shopping center with good demographic growth could be as low as sub 3% cap. Different people seek different situations based on their objectives, so one isn\u2019t necessarily better than another unless you can directly measure similar assets, apples to apples.", "replies": [], "depth": 2}], "depth": 1}, {"id": "i4txmzi", "text": "1. A cap rate of X% could be good in one market but bad in another. It just depends on how other properties are trading in each market. For example an 8% cap rate might be good (from a sellers perspective) for a main street retail property, but an 8% cap rate for a class a multifamily property could be bad. \n\n2. This is a very complicated question that cannot be answered by one metric.\n\n3. Cap rates don't affect pricing. They're representations of pricing. Pricing affects the cap rate, not the other way around. \n\n4. Not enough information\n\n5. I=RV   Income = Rate x Value or to better answer your question R =I/V. The cap rate is affected equally by both the Income level and the sale price. I don't mean dollar for dollar but rather both inputs are half of the equation.\n\n6. I don't understand this question. \n\n7. If income is rising at a faster rate than cap rates, that means investors are paying less for that income than they were before. A higher cap rate means lower returns (from the seller's perspective)\n\n8. Federal interest rate is a measure of how expensive it is to buy money. Investors will have less access to cash for purchasing buildings. Therefore in theory prices would go down. If prices go down but income remains the same then cap rates rise. So there should be correlation between higher fed interest rates leading to higher cap rates.\n\n9. It means investors are able to get more income for their capital dollars in San Fransisco than the overall nation at large.\n\n10. Cap Rate and Yield Rate are slightly different things. Cap Rate's denominator is Property Value which changes over time. A Yield Rate's denominator is the Cost which is a static number. It depends on what perspective you're looking at cap rates and yield rates. Sometimes they'll give you the same output but its not really telling you the same thing. \n\nHope this helped.", "replies": [{"id": "i4u8lx7", "text": "Great answer overall. #3 is spot on!", "replies": [{"id": "i4vwt7c", "text": "Agreed. All are good. Thanks u/freshOJ for taking the time to write that up.  OP - read #3 again and again. So many people, who have been in the industry a long time, get this backwards.  People who should know better IMO.", "replies": [], "depth": 3}], "depth": 2}, {"id": "i4vgcs0", "text": "&gt;If income is rising at a faster rate than cap rates, that means investors are paying less for that income than they were before. A higher cap rate means lower returns (from the seller's perspective)\n\nIf NOI increases then the VALUE goes up not the cap rate.", "replies": [], "depth": 2}, {"id": "i4w8asf", "text": "&gt;Cap rates don't affect pricing. They're representations of pricing. Pricing affects the cap rate, not the other way around.\n\nFor clarification, cap rate comps do affect pricing.  If NOI is selling for a 10% cap rate in a market you will have a hard time buying at a 12% cap rate.  But, yes if several sellers do sell for 12% because they believe the market is changing then those sales will establish new comps.", "replies": [], "depth": 2}, {"id": "i4wdmv7", "text": "&gt;It means investors are able to get more income for their capital dollars in San Fransisco than the overall nation at large.\n\nThe OP's question was**\\*\\*. \"What does it mean if San Francisco cap rate is lower than average national cap rate?\"\\*\\***\n\nIf you are calling income NOI then the lower cap rate in SF means that investors are paying MORE for each NOI dollar.  So they are getting \"less\" NOI (income) than what investors are getting in Podunk.  Isn't that correct?", "replies": [], "depth": 2}], "depth": 1}, {"id": "i4u6vwk", "text": "Did you just post questions from your homework assignment?", "replies": [{"id": "i4ubtyt", "text": "No, these are questions that came to mind to help me understand cap rate better.", "replies": [], "depth": 2}], "depth": 1}, {"id": "i4u8hpb", "text": "Cap rate is a simplified return metric if you paid cash for the investment. \n\nIf I buy a $1mm property that has an NOI of $100k 10 cap. If that same property makes $50k NOI 5 cap.", "replies": [], "depth": 1}, {"id": "i4uw21l", "text": "Cap rates should mainly be used as a measure of expected return (and risk) at a point in time on a *stabilized deal, if paying all cash*. Not the only measure but certainly an important one in that circumstance. \n\nMany investors or sellers use it simply as a valuation number  but perhaps miss that it's a really a return and risk measurement metric in a very tightly bound circumstance.\n\nIf a property is not stabilized or a value add deal, Yield on Cost is the better metric at purchase since the going-in  cap rate calculation will always be compressed reflecting a higher price on low NOI that has room to grow.", "replies": [{"id": "i4ve9rs", "text": "&gt;Cap rates should mainly be used as a measure of expected return (and risk) at a point in time on a  \n&gt;  \n&gt;stabilized deal, **if paying all cash**  \n&gt;  \n&gt;.\n\nu/K3IKI\n\nCap rates do not measure risk or \"returns\".  Cap rates measure VALUE.\n\nThere is no such thing as an unleveraged cap rate.  Property A has $50,000 NOI and sells for $500,000.  That is a 10% cap.  It is financed 100%.  Property B has $50,000 NOI and sells for $500,000 at a 10 cap.  It was bought for cash.  See, the cap rate is the SAME, Now here is where this misconception comes from.  Cash on cash return is a return metric.  If you pay cash then the cap rate and the CoC return will be the same number but they do not measure the same things.", "replies": [{"id": "i4vfo6y", "text": "Question. Who finances that 100% you are talking about? What's their return?", "replies": [{"id": "i4vhd7w", "text": "Hard money? Grandma?  It is not relevant to the cap rate.", "replies": [{"id": "i4vhocp", "text": "Exactly. Hence *unleveraged*. The return that the Net Operating Income produces in relation to the purchase price. Your cap rate. I thought you knew this stuff youve been hanging around here forever.", "replies": [{"id": "i4voxox", "text": "Leverage has NOTHING to do with cap rates.  As I stated they are the same with or without leverage.  They do not measure returns.  A 5 cap can produce higher returns than a ten cap.  Any investor should know that.\n\nWhy would a seller only ask for $10 for a dollar of NOI 10% cap when a seller in a 5 cap market is getting $20?  So the buyer has a higher \"return\"?  LOL", "replies": [{"id": "i4vq6tc", "text": "What % of returns do a 5 cap produce? or a 10 cap?", "replies": [{"id": "i4vth7m", "text": "Depends on what return metric you use.  I am just correctly stating that cap rates just tell you what an investor paid for a possible dollar of NOI.  Now cap rates can be indicative of both risk and return but they don't measure either.  \n\nFrom my experience the more an investor pays for NOI comparatively the higher total return the investor expects.", "replies": [{"id": "i4vttdi", "text": "huh?\n\nThere's a reason it's a 5% capitalization rate. Not simply a \"5 cap\"..c'mon man..It's not just some arbitrary reverse multiplier. The % show the expect yield % from the income at a point in time when a certain price paid.", "replies": [{"id": "i4vyfiq", "text": "&gt;The % show the expect yield % from the income at a point in time when a certain price paid.\n\nV=i/r   $10=$1/10%   The value of that dollar of NOI is $10.  Where is the \"return\"?\n\nSo if I sell you $100,000 NOI for $1,000,000 do you think you will get a 10% return?", "replies": [{"id": "i4vyxr9", "text": "Paying all cash, at the end of year one on a fully occupied property at market rents, yes that would be my expection.\n\nIf I was willing to accept a 5% return for the same NOI and circumstances, I'd would be willing to pay you $2,000,000", "replies": [{"id": "i4w00sh", "text": "Fool!\\*  I just sold you $100,000 NOI for $1,000,000 in a 15% cap rate market!  I just had you OVERPAY by $333,333!!  V=i/r  $666,667=$100,000/15%\n\nWhere's your 10% \"return\"?  This is too evil/easy.\n\n&amp;#x200B;\n\n\\*In loving memory of Gilbert Gottfried", "replies": [{"id": "i4w0u8f", "text": "What 15% cap rate market? WTH are you talking about?\n\nWe, the buyer and seller, make the market on this property.\n\nI paid you $1m for $100k in solid ongoing income. My 10% yield is my target return. I got it from you. If I wanted 15% I would have offered $666,666 --", "replies": [{"id": "i4w67tt", "text": "&gt;If I wanted 15% I would have offered $666,666 \n\nEXACTLY! $666,667 was what other interested parties offered because all the cap rate comps were 15%.  Since you think a cap rate is a \"return\" and will settle for 10% you paid me $1,000,000 (cue Dr. Evil voice) I scammed you!  \n\nBut why would you settle for a 10% \"return\" when you could have gotten a 15% \"return\"?", "replies": [{"id": "i4ymglt", "text": "Anyway OP if you are still watching the thread after this idiotic exchange. Take what hono says with a grain of salt. He seems to think there's some sort of \\*Cap Rate Commission\\* out there that magically sets the prices of commercial real estate. When in reality, cap rates are calculated after the fact of a transaction. Sometimes way after the fact.\n\nA willing buyer and a seller create the market on a property in a transaction. From the buyer's point of view, one way they can calculate potential \"unlevered\" (cash purchased) yield on a stabilized property is by calculating the cap rate by dividing the purchase price from the stabilized NOI. In an actual transaction, the Price = the Value.\n\nFrom the seller's perspective, who knows. Maybe they are like Honobob, gleefully swinging their pajamas in the air because they made money on the transaction. But then the question might be why are they so excited that they got a certain cap rate when they would be better served by calculating their own rate of return, return on their costs, or multiple on invested capital?\n\nThe only 3rd parties that might matter in a transaction and who might look at cap rates as a leading indicator of value, are appraisers and lenders. In a cash transaction, the appraiser doesn't matter unless one or the other of the buyer and seller want an appraisal. Lenders don't matter in a cash transaction either. In a financed transaction they will be sizing to debt yield (there's that yield word again) and debt service coverage ratio among other things.", "replies": [{"id": "i4zqh8e", "text": "&gt; Take what hono says with a grain of salt. He seems to think there's some sort of \\*Cap Rate Commission\\* out there that magically sets the prices of commercial real estate. When in reality, cap rates are calculated after the fact of a transaction. Sometimes way after the fact.\n\nJust Geez!  Cap rates come from closed sales.  They tell you what dollar amount the buyer and seller agreed to exchange NOI.  I mathematically showed you how I SCAMMED you out of $333,333 because you don't understand cap rates.  \n\nEven funnier is that you walked away thinking you got a **10% \"return**\" and have no clue that you got royally scammed!  Now our closed sale will be analyzed and sure enough they will determine that you bought at a 10 cap!!!  Is this a sign that the market has changed or just some smuck that got scammed? Well since all the other sales have been at 15% I gotta say smuck!", "replies": [], "depth": 16}], "depth": 15}], "depth": 14}], "depth": 13}], "depth": 12}], "depth": 11}], "depth": 10}], "depth": 9}], "depth": 8}], "depth": 7}], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "i4vimx0", "text": "First let's get you started correctly about what cap rates are.  Cap rates come from an income approach to value called direct capitalization.  The formula is V=i/r  The V is the value you want to solve for.  the i is the NOI the property is capable of producing at stabilized market and the r is the capitalization rate that similar properties have sold for.\n\nSo in a 5 cap market a dollar of NOI is selling for $20=$1/5% and in a 10 cap market that same possible dollar of NOI is only selling for $10=$1/10%.  Forget the percentage, that is where people go wrong and think a percentage means a \"return\".\n\nNow go back and answer your own questions based on the actual dollar amount that investors HAVE paid for NOI.\n\nhttps://www.reddit.com/r/CommercialRealEstate/comments/tuupty/the\\_income\\_approach\\_to\\_value\\_cap\\_rates\\_explained/", "replies": [{"id": "i4w07e1", "text": "100% correct, but also important to understand that if you\u2019re looking at NNN deals \u201ccap rate\u201d is almost exclusively \u2018calculated\u2019 using in-place, annualized NOI, with no market/vacancy adjustments. Might not be correct, but it\u2019s basically ubiquitous at this point and important to understand.", "replies": [], "depth": 2}], "depth": 1}, {"id": "i4vlrjj", "text": "Income good. Expenses bad.\nCash app is fine from my consultation fee.", "replies": [], "depth": 1}, {"id": "i4vn3py", "text": "Hey again, let me see if I can help out here.\n\n1. It\u2019s all relative to the market and type of property. A 5% cap rate is not the same if you\u2019re buying multifamily as if you\u2019re buying retail (for multifamily you\u2019re getting that property very cheap in most markets, but for retail it\u2019s in the expensive side for most types). That can vary between markets/cities as well as a property type might be more popular in one place than another. It all comes down to what comparable properties are trading at.\n\n2. There\u2019s no simple answer here it comes with experience and market knowledge. The numbers are only part of the story but for starters get an understanding of how to calculate and interpret return metrics.\n\n3. Cap rates are a way to interpret or back into pricing. They\u2019re a metric of what properties are trading at price-wise relative to NOI, so someone may say retail is trading at a 5 cap in the market which means if a property is generating 100k NOI then investors in that market should value it around $2M.\n\n4. Houses aren\u2019t valued with a cap rate. Very different type of investment, generally they\u2019re not a cash flow investment.\n\n5. Again, these are all interrelated. Cap rate = NOI/Value (or purchase price), therefore Value = NOI/Cap Rate and NOI = Cap Rate*Value\n\n6. I think you need to go watch videos on this and do some reading. A cap rate is literally just determined by a formula based on the price people are willing to pay for NOI. Its the inverse of price as a multiple of NOI. Obviously people are going to be willing to pay a different multiple on NOI for an identical property that\u2019s in a growing, high income neighborhood than if that property was in a slum.\n\nTo put it in residential RE terms, if a 5 bedroom house was in the nicest part of town in walking distance of good restaurants and necessities wouldn\u2019t you pay more for it than if the exact same house was in the boonies?\n\n7. FreshOJ did a good job with this question but would like to add that higher cap rates don\u2019t always = better returns for the buyer. The reason one property might trade at a higher cap rate is generally because it\u2019s also higher risk, there\u2019s a bigger likelihood of something going wrong. Assuming things go perfectly according to plan then yes you should get a higher return but you always have to weigh downside risk. For example, with apartments you have a bunch of leases and all are short term so you can increase rents annually and if one tenant vacates it\u2019s not the end of the world. With retail you often lock tenants in for 5-10 years so if rents go through the roof suddenly your rents are below market, and if you have a huge anchor tenant vacate suddenly 30% of your revenue can disappear.\n\n8. As interest rates rise debt gets more expensive so people are willing to pay less for the income a property generates (since they need to cover their debt service requirements and achieve acceptable returns), so cap rates rise.\n\n9. That investors will pay more for a property in SF than an equivalent property in the average market.\n\n10. Cap rate isn\u2019t how much you earn, it\u2019s how much the property generates from operations. It doesn\u2019t account for capital expenditures (I.e. roof replacements or other major renovations), leasing costs, any asset management fees, or the cost of paying your mortgage. Cash on cash or return on equity are the metrics to look at actual yield to the investor.", "replies": [], "depth": 1}, {"id": "i4vv5qm", "text": "Remember that cap rates are only useful within ranges and only representative of income over a very specific time frame. You will hear 'in place', 'pro forma' and even T3 &amp; T6 used to refer to cap rates but they're all completely different things.\n\nFor example if you bought a vacant 4-unit apartment complex for $1 your cap rate would be 0%. Terrible investment right? Well what if you leased each unit for $1 per month the day after you bought it? You've just 48x-ed your purchase price so yeah that 0% cap is meaningless.\n\nThis is why things like replacement cost, IRR, stabilized yield, etc. etc. etc. are used to value real estate, because cash flow changes over time. Cap rates are only meaningful for stabilized properties in markets with good exit liquidity involving an arms length transaction between sophisticated entities.\n\nAlso what you're referring to with the single family example isn't a cap rate. That's cash on cash - i.e. annual income after debt service divided by purchase price less loan proceeds. I.e. if I got a 50% loan @ 10% I/O (interest only) for the $1 quadplex my CoC is ($48 - ($1 x 50% x 10%)) / ($1 - ($1 x 50%)) or $47.95 / $0.50 or 9,590% cash-on-cash.\n\nI could put four absolute bangers on a page and they would all look completely different. A good investment in real estate has nothing to do with identifying some single magic variable that allows you to completely turn off your brain. You just have to look at your shit, drive around and find some other shit that looks similar, find out who owns it and call them and ask them about their shit, and then go on a walk and let it marinate inside of your head. 99% of opportunities are there because the smart money passed and it's a broker's job to make it seem like the bee's knees. And maybe it is! Sometimes there are idiots out there who sound like a joke when you ask them simple questions about the market but they've stumbled onto gold. Sometimes you've got a smooth talker who's selling used cars. But you won't know until you put your brain on it. And you can't substitute someone else's for your own and expect any kind of lasting success.", "replies": [], "depth": 1}]