What is the difference between cap rate, and cash-on-cash return, and yield?
When and why would you use each of these terms?
[{"id": "halj5gg", "text": "Take a CCIM course", "replies": [], "depth": 1}, {"id": "haln9cl", "text": "\\--Cap Rate is a function of price and NOI.  Cap Rate = NOI/Price\n\n\\--Cash on Cash Return is the annual % in cash you receive as a function of the equity invested.  If I invest 1M and get back 100k/year = 10% Cash on Cash.\n\n&amp;#x200B;\n\n\\--Yield can be synonymous with 'return'.  Two examples are:\n\n1. leveraged yield: basically your cash on cash return.\n2. unleveraged yield: cash returns without any debt on the property (cash purchase)\n\n&amp;#x200B;\n\nThose are the basics", "replies": [{"id": "han0qog", "text": "Just so you know - cap rate is typically a function of perceived stability of the asset in CRE.\n\n\nLow (4-6.5%) is perceived as very stable.\n\nMid (6.5-8.5) is considered acceptable risk and where most of the value add deals are\n\nHigh (8.5-20) are considered \u201chairy\u201d deals that need an investor to help clean them up and for that they pay out stupid returns.\n\nSo in essence if you\u2019re after your highest cash on cash return and don\u2019t mind the risk sure high cap rate deals are awesome...\n\nIf you\u2019re playing to make money long run and don\u2019t want that much risk go mid range.\n\nIf you\u2019re institutional (you\u2019re not but if you get there) you\u2019re wanting bond like stability with better rate of return stay low cap rate.\n\nThe cap rates above are reflective of my market. You will need to evaluate your own market and look at what it\u2019s breakdown is.\n\nI hope you found this helpful when using cap rates to look at deals.", "replies": [], "depth": 2}], "depth": 1}, {"id": "ham7imi", "text": "Cap rate is basically what percent return (unlevered) an investor is willing to pay for a type of asset in a particular market. So say you are in Seattle and want to buy an apartment building. In good areas of the city and investor may be willing to accept a 5% rate of return without debt but in a worse part of the city and investor would want to see 6% to make it worth his while. Cap rates are determined by comparable sales and are heavily impacted by interest rates. If you see bldg A sell for $1m and producing 100k noi and bldg B sell for $2m and producing $200k noi, the cap rate in both is 10 and should be used to value other similar buildings.\n\nCash on cash return is what you can pocket after expenses and the mortgage. A higher cap rate paired with a lower interest rate is going to provide a higher cash on cash return. Cash flow is only 1 of 4 ways to make financial gains in real estate, with the others being tax write offs, appreciation and principal reduction with a mortgage. None of those other ways are built into the cash on cash metric.\n\nYield is a bit arbitrary and I typically do not see it used in commercial real estate.", "replies": [{"id": "ham873o", "text": "\ud83d\udc4d", "replies": [{"id": "hamfbax", "text": "As a heads up to both OP and others reading, this response misleading at best about cap rate and incorrect about cash on cash. See top response for the right answers.", "replies": [{"id": "hao1cd8", "text": "As a heads up to both OP and others reading, the above \"heads up\" is full of shit. The explanation offered by \"SayJeff\" is one of many good explanations of / to the OP's question. It just happens to be overly simplified, which, if the OP can't find this info with a 3 second Google search is probably a highly appropriate approach.", "replies": [{"id": "hapnczn", "text": "Thank you CriticalEscapeBike. I am glad you recognize that it is a true but overly simplified explanation. Have been working with cap rates for 12 years and it didnt seem like OP wanted an essay.", "replies": [{"id": "hapvar9", "text": "I do want an essay. There are many misleading information about the relationship between these terms on search engines.", "replies": [{"id": "haq3rpw", "text": "Here are 2,290,000,000 results on cap rates:  [https://www.google.com/search?client=firefox-b-1-d&amp;q=what+is+a+cap+rate%3F](https://www.google.com/search?client=firefox-b-1-d&amp;q=what+is+a+cap+rate%3F)\n\nThe first 30 are accurate and well written.\n\n(I presume the remaining 2,289,999,970 are equally as informative).", "replies": [], "depth": 7}], "depth": 6}], "depth": 5}, {"id": "hb4i1fl", "text": "&gt;The explanation offered by \"SayJeff\" is one of many good explanations \n\nA cap rate is a valuation metric.  How could it be a \"return\"?  A seller in a 10% cap rate market can sell his $100,000 NOI for $1,000,000. A seller in a 5% cap rate market can get $2,000,000 for the same $100,000 NOI. If a cap rate WAS a return why is TWICE the \"return\" selling for HALF the price?", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}, {"id": "haysgqk", "text": "&gt;Cap rate is basically what percent return (unlevered) an investor is willing to pay for a type of asset in a particular market.\n\nInvestors don't pay \"return\".  Cap rates are a valuation metric and have absolutely NOTHING to do with leverage.  a cap rate will be exactly the same whether you pay all cash or finance 100%.", "replies": [{"id": "hayw5td", "text": "An investor pays for an asset and accepts a rate of return on that asset. I specified in my original post that it was unlevered, having nothing to do with debt.", "replies": [{"id": "hayxvin", "text": "The rate of return is not measured by the cap rate.  The cap rate just tells you what you are paying.  If you pay market you can probably expect market return however you measure that.  \n\nCap rates have nothing to do with leverage.  They are exactly the same whether you pay cash or finance 100%.  You are confusing cash on cash calculation with no leverage.  that changes depending on the leverage but cap rate does not.", "replies": [{"id": "hayyw67", "text": "I don\u2019t know where you are seeing that I am saying it is tied to debt. I agree it is not tied to debt. And it 100% corresponds to rate of return if you are not using leverage. A 7 cap without debt will produce a 7% rate of return.", "replies": [{"id": "haz0hv8", "text": "&gt;I don\u2019t know where you are seeing that I am saying it is tied to debt.\n\nDo you know what leverage is?  You are saying a cap rate is a rate of return \"if you are not using leverage\" \"without debt\",  Those are your words.  A 7 cap is not a 7% rate of return because cap rates do not measure returns.  All that 7 cap means is that you paid $14.29 for each possible dollar of NOI.  That is not a return, it is a valuation.", "replies": [{"id": "haz1huc", "text": "So you disagree with me if I say that buying a building at a 7 cap rate without using debt would give me a 7% return?", "replies": [{"id": "haz4jeb", "text": "I am saying that cap rates do not measure returns.\n\nAre you saying that if I pay $1,428,571 for $100,000 NOI that I will get a 7% return?", "replies": [], "depth": 8}], "depth": 7}], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "hamc96g", "text": "Google.", "replies": [], "depth": 1}, {"id": "hand9mg", "text": "Can\u2019t you just look this up on your own?", "replies": [], "depth": 1}, {"id": "harsljc", "text": "Easiest way to understand this is both are measuring your rate of return on your initial equity put into the property. \n\nCap Rate illustrates you purchasing the property all cash so your equity is the total purchase price of the property. \n\nCOC is you purchasing the property with financing. So your COC would be your annual net income (after debt service) divided by your down payment on the loan which is your equity. \n\nThis is important to know because sometimes financing a property results in negative leverage. I.E. the cap rate is 5% (so I get a 5% annual return on my equity if I pay all cash) but my COC is 4.16% (meaning I get a 4.16% return on my equity if I finance the property) so it makes more sense to pay all cash, otherwise I\u2019ll lose 84bps on my annual return. Granted there is more to this since you may get more depreciation and the benefit of principal pay down by leveraging up and buying a larger property.\n\nPlease do note this explanation has nothing to do with how Cap Rates are assigned to properties. If you want to know the MANY things I look for when assigning a cap rate to retail properties, let me know, and I\u2019ll break it down. (Very different for single and multi)", "replies": [{"id": "hayt3ra", "text": "&gt; Cap Rates are assigned to properties. If you want to know the MANY things I look for when assigning a cap rate to retail properties, \n\nWhat does this \"assigning cap rates\" mean?", "replies": [], "depth": 2}], "depth": 1}, {"id": "hayovdv", "text": "1. Cap rates come from an income approach to value called direct capitalization where 12 months of NOI is converted into a market value using cap rate comps from analyzed closed sales of similar properties.\n2. Yield capitalization is similar but uses multiple years of NOI and discount rates.\n\nNeither of these measure returns.\n\n3.  Cash on cash is a return metric utilizing NOI and leverage.\n\nScammers want you to believe that a cap rate is a \"return\".  They have properties that they buy at a 12% cap rate $8.33=$1/12%  and convince novices that they can buy from them at a 10% cap rate and have a 10% \"return\"!!!!   But that just means that they marked up the cost of NOI to $10 V=i/r  $10=$1/10% so for each dollar of possible NOI you are overpaying $1.67 or 20% overpriced!!!  Guess who is making money on that deal!\n\nCap rates don't measure \"returns\" or risk.  Don't be scammed.  And yes 99% of the internet has this wrong but there is big money is scamming you.", "replies": [], "depth": 1}, {"id": "hazzovn", "text": "u/sayjeff  Didn't mean to stop you in your tracks but here is another mind blowing thought.  A seller in a 10% cap rate market can sell his $100,000 NOI for $1,000,000.   A seller in a 5% cap rate market can get $2,000,000 for the same $100,000 NOI.  If a cap rate WAS a return why is TWICE the \"return\" selling for HALF  the price?", "replies": [], "depth": 1}]