Question on cap rate and return on investment? Are they the same?
When someone says "I want to make 8-10% return on my money" is that the same as a 8-10% cap rate?
[{"id": "ip72z9e", "text": "No\n\nCap rates are NOI / Price\n\nIRR is cashflow after tax plus reversionary value on sale after x years", "replies": [], "depth": 1}, {"id": "ip75i79", "text": "u/honobob    Sending up the cap signal", "replies": [{"id": "ip85m2h", "text": "He'll be swooping in ... Cap Rate guns a blazing !!!!", "replies": [{"id": "ip88ozc", "text": "Giving you truth, justice and the American way!", "replies": [{"id": "ip8aw7j", "text": "Love it! \ud83d\ude02", "replies": [], "depth": 4}], "depth": 3}, {"id": "ip8av0m", "text": "LOL love it \ud83d\ude02", "replies": [], "depth": 3}, {"id": "ipduptp", "text": "I will never disappoint you.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "ip79bcw", "text": "Cap rates are a valuation metric for NOI.  The formula is V=i/r.  A 10 cap means NOI is selling for $10 and each dollar increase in NOI should result in a $10 increase in value.  $10=$1/10%\n\nAn 8 cap means the market is valuing that dollar of NOI at $12.50.\n\nOut of the NOI will come capex and debt service.\n\n\nAnd once you determine the probable market value you can make return calculations like ROI, ROE, IRR ETC.\n\nhttps://m.youtube.com/shorts/j-NZpDAag98", "replies": [], "depth": 1}, {"id": "ip7kcjl", "text": " Nope.\n\nCap rate is the Net Operating Income / Price. It's very useful in comparing against the interest rate. For example, if interest rates are 6% and the cap rate is 9%, then you're earning an extra 3% on the deal for every dollar that you borrow.\n\nThere's Return on Investment (ROI) which indicates total growth, start to finish, of an investment. Internal Rate of Return (IRR) identifies the annual growth rate.\n\nIn that same example (assuming you keep the property for simplicity's sake), if you put 30% down, then you would be earning 9% on the 30% you put down, and 3% on the 70% loan, so your IRR and Return on Investment for 1 year would be 0.09+0.03\\*0.7 = 11.1%.\n\n&amp;#x200B;\n\nOf course that's not accounting for taxes, inflation, appreciation and doesn't account for if you sell. Hope that helps!", "replies": [{"id": "ip7vy0m", "text": "\"For example, if interest rates are 6% and the cap rate is 9%, then you're earning an extra 3% on the deal for every dollar that you borrow.\"\n\nA 9% cap rate does not mean you are \"earning\" 9%.  All it means is that you paid $11.11 for each possible dollar of NOI.  $11.11=$1/9%", "replies": [{"id": "ip8gr7n", "text": "I didn't say that it was. I said that you're earning an extra 3% for every dollar that you borrow. If you really want to dig into the weeds then sure, the gap between the cap rate and the loan still needs to take into account a proportional share of taxes. I'm just giving OP a way that one can use cap rates when reviewing deals.", "replies": [{"id": "ip8jed4", "text": "But this makes no sense since all the 9% cap rate means is that you paid $11.11 for a possible dollar of NOI.  There is no 9%-6%!  \n\nIf there was you could buy in Podunk at a 15% cap rate and make 15-6=9%!!!!!!\n\nThat is like eleventy four more.  LOL", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}, {"id": "ipdbisb", "text": "I'm not trying to be difficult, but I'm having a difficult time with understanding this.  ROI is return on investment.  The loan you take out isn't your investment.  If you put 30% down, your investment is the 30%.  \n\nLet's use your example of a 9% cap rate for the property.  So let's say you bought the property for $1M, and it has a $90,000 NOI that it is producing.  If you invest 30%, and you put down 300,000, you're going to borrow 700,000 at your 6% rate which will have an annual IO payment of $42,000.  So this means now your investment of $300,000 is bringing in the 90,000 less the interest payment of $42,000 with a final amount of $48,000.  \n\nWouldn't this then mean that our return of $48,000 on our investment of $300,000 (ROI) is actually 16%?  \n\nNow, the IRR can't be calculated with just one or two years.  IRR is an internal rate of return which takes into account the investment and then the cash flows over a period of time, giving you an annual return for that duration.  Let's use this example.  You invest 300,000 in year 0, then you get cash flows of 48,000 for the next 4 years and then in the 5th year, you get the 48,000 and sell the property for $1,100,000, getting cashflow of 448,000 in that last year (after the loan is paid off).  Then you'd have the following cashflow:\n\n(300,000) | 48,000 | 48,000 | 48,000 | 48,000 | 448,000\n\nThe IRR here after 5 years would be 22%.  If you did an IRR for only the investment and then 1 year of NOI, then IRR would be -84% (which isn't even practical or something you would calculate because it doesn't really make sense and it isn't how IRR was meant to be used).  \n\nI might be misunderstanding how ROI and IRR work, so I'll try and brush up on some of my CRE books where the topic is discussed.  I could be missing something here.", "replies": [], "depth": 2}], "depth": 1}, {"id": "ip8h287", "text": "U/SagHarbor85. \n\nYou want a 10% \"return\"?   I have $100,000 NOI to sell you.  At your 10% cap rate you pay me $1,000,000.  You think you are making a 10% \"return\"! LOL\n\nNow since I am not a novice CRE investor I know that cap rates are a valuation metric and not a return so I bought at market cap rate of 15%. So I paid only $6.67 for a dollar of NOI so I profited $3.33 on every dollar of NOI!!!!  Return?  I think not.", "replies": [], "depth": 1}, {"id": "ip8tvj2", "text": "The easiest way to think of cap rate is it converts the net income from one year to a value.\n\nWhen someone says they want to make \\*\\*% on their money, it can mean overall yield (like IRR), or it can be equity yield (cash flow received vs equity invested).", "replies": [], "depth": 1}, {"id": "ip8ylkw", "text": "Nope. A lot of good advice on here though.", "replies": [], "depth": 1}, {"id": "ip9ppjx", "text": "I gotta say, all the response above are throwing me for a loop. Put simply, cap rate just tells you the return of your investment in comparison to how much you agreed to pay for an investment. Your return on investment on the other hand is how much you are making  relative to how much money you invested.\n\nExample: \n\nIf you buy a house for 100k, you put 20% down= 20k. And the house generates $6000 annually in income. Edit: (6k in Net Operating Income, that is income after expenses are deducted)\n\nYour cap rate is 6000/100000 = 6%\nYour ROI is 6000/20000= 30% \n\nBasically, with the cap rate, you can take that number and compare it to other houses in the market. A house that can generate 10% cap rate compared to 6 basically means you are making more 4% more money on that property compared to any other, which helps you determine how much is best to offer. Cap rate gives you a very simple way to compare market returns and how much money to pay for a property.\n\nROI just tells you how good your investment is,  in my example above your initial 20k investment is make you an annualized 30% return. Actually it\u2019s probably lower because cap rate doesn\u2019t include debt servicing. So in reality, that 6k annually is maybe 2k if you factor for debt servicing, so your true ROI is 10%. This is the number you can compare to the interest rate. This number basically states that compared to parking your money at the national prom rate of 5%, your property is making twice that number. \n\nThe combination of this two factors allow you to 1. Verify that you are getting a good deal on your purchase- not overpaying. \n2. That your purchase is a good use of your money compared to any other alternatives. \n\nHope this helps.", "replies": [{"id": "ip9s16o", "text": "Sir, there are no cap rates on SFR's.  You have been scammed bigly!", "replies": [{"id": "ip9sf48", "text": "Respectfully, disagree. There is.\n\nhttps://www.wealthmanagement.com/sfr/sentiment-remains-strong-sfr-sector#:~:text=This%20represents%20the%20highest%20level,from%205.9%20percent%20in%202020.", "replies": [{"id": "ipa5gti", "text": "Nope! SFR'S are easily valued by the more accurate sales comparison method.\n\nGeez, where would you get a reliable source of cap rate comps?  Someone has scammed you!!!", "replies": [], "depth": 4}, {"id": "ipbg79x", "text": "The comparison method is an appraisal approach to valuing a home. Takes into account local sales only of similar homes. Unlike the cap rate, it doesn\u2019t take the properties ability to generate income into account. Two different things.", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}, {"id": "ipa74zk", "text": "A SFR purchase is not commercial real estate.  You should go to the BP forum where $40 a month allows you to call yourself a \"pro\".  You are in the wrong forum.", "replies": [], "depth": 2}, {"id": "ipajquo", "text": "Using cap rate as only a return metric is scary stuff. Your explanation puts the concept in a vacuum.\n\nIn your example the first question I would ask is why is there a difference in the cap rate.", "replies": [{"id": "ipc5sjr", "text": "I wouldn\u2019t use cap rate as the only yardstick, and I don\u2019t think I am suggesting that. Just saying what the metrics could help with concluding.", "replies": [{"id": "ipcjdxg", "text": "That is far from a conclusion, rather it helps guide your questioning of the investment opportunity.\n\n1) what NOI are they using? How does it compare to your underwriting/ going in cap? \n2) lower cap implies  lower risk. Why is this deal implied to be less risky by the seller?\n3) how does the direct cap approach to value compare to cost approach, DCF, sales comparison approach? Why is there, if any a delta?", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}, {"id": "ipc4zx5", "text": "Not sure if you meant \"generates $6000 annually in net operating income.\" Cap rates are a function of income net of expenses, before debt service. You may know this, just clarifying for anyone else who finds this searching for an answer.\n\nAlso, SFRs valued on cap rate seems silly for a few reasons, biggest for me is that the next buyer likely doesn't know and/or care about cap rates and will value the asset based on nearby sales comps.", "replies": [{"id": "ipc5xik", "text": "Good catch- I have edited! What if the next buyer was an investor as opposed to an owner occupied?", "replies": [{"id": "ipc9aur", "text": "No prob! \n\nRegarding the next buyer, they could be, but now your speculating and/or limiting your buyer pool. Good investments should have multiple exit strategies IMO, so if it works on a cap rate basis, and on a sales comp basis, then who cares? The problem arises when the investment works from a cap rate valuation ONLY, since 90% (huge assumption on my end) of SFR buyers, investors or homeowners won't value it that way.", "replies": [], "depth": 4}], "depth": 3}, {"id": "ipcvogp", "text": "\"Also, SFRs valued on cap rate seems silly for a few reasons, biggest for me is that the next buyer likely doesn't know and/or care about cap rates and will value the asset based on nearby sales comps.\"\n\nExactly!  And where is there a verifiable reliable source of cap rate comps?  There is no such thing.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "ipa8e31", "text": "Some great answers. You may find value in this brief write-up on the two, as well. \n\nhttps://www.moneyweighted.com/capitalization-rate-vs-internal-rate-of-return-what-you-need-to-know/\n\nHey, if you are not privy, I would also recommend investopedia.com for great (better than mine) intro articles on all things finance. All the best!", "replies": [{"id": "ipa9y1n", "text": "Total CRAP!  If you can only sell $1 of NOI for $10 you bought at a 10% cap rate.  If you can get $20 for a dollar of NOI you are buying at a 5% cap rate.  \n\nSee? All it is is a valuation metric!  You guys are being bamboozled!", "replies": [{"id": "ipabvi3", "text": "Ha. You have quiet the history and your single-minded devotion to right the world\u2019s understanding of \u201ccap rates\u201d via Reddit is commendable. I only wish you the best.", "replies": [{"id": "ipacqme", "text": "So have you seen the light and recognize the correct application of cap rates?", "replies": [{"id": "ipadn9m", "text": "Like catching the eye of an insane person on the train\u2026I will politely agree and hope you move on.", "replies": [{"id": "ipadxhb", "text": "Move on to what?  JFC, answer the question if you can or move on.  You are not adding anything to CRE.", "replies": [], "depth": 6}], "depth": 5}], "depth": 4}, {"id": "ipad9mf", "text": "Quite", "replies": [{"id": "ipadz0z", "text": "Touch\u2026\nTouche \u2026\nTouch\u00e9 \u2026\nWell played.", "replies": [{"id": "ipaed67", "text": "Quiet deflecting and stick to the subject matter.", "replies": [], "depth": 6}], "depth": 5}], "depth": 4}, {"id": "ipn87mv", "text": "https://m.youtube.com/shorts/j-NZpDAag98", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "ipamv9h", "text": "Cap rate is point in time yield of the asset. It\u2019s just the inverse of a PE multiple because real estate is typically evaluated based on a risk premium to treasuries.\n\nWhen investors target a return, they\u2019re typically talking about a total return over a certain hold period and will look at a levered return (with debt) on their equity. They\u2019re factoring in a bunch of variables like rent growth, expenses, debt service, capex, cap rate at exit, etc.", "replies": [], "depth": 1}, {"id": "ipc2pdu", "text": "Property cap rates are a snapshot in time, just a ratio of current NOI and your all-in price. \n\nReturn on investment is a calculation of all contributions to and distributions from the investment over a period of time.", "replies": [], "depth": 1}]