Help! NNN leases, Cap rate, NOI, loan terms, oh my!
I am learning about CRE. I’m sure the answer is basic but can’t wrap my head around it. A lot of triple net lease CRE listings that I am looking at advertise the cap rate, which varies from 4-8% for many of these properties. If cap rate is defined as  NOI/property value, and I purchase a property for 3M and the cap rate is 5%, my NOI is 150k/year. The way I understand NOI is that it is net operating income, which I thought was gross minus expenses; so basically the money I take home (pre-tax). But how do they calculate cap rate and what my NOI is if they do not know the terms of my loan financing? Say my down payment was low and my loan term was short, then my monthly mortgage payment would be high, causing my expenses to be higher causing my NOI to be very low. Conversely my NOI (and cap rate would be high) if my down payment high, loan term long, this monthly mortgage low. Are they calculating NOI and cap rate based on the current seller’s loan terms? Some generally accepted loan terms? And if most NNN loans are based on the remaining years on the tenant’s current lease term, the cap rate and NOI would change drastically year after year and would cause them to be extremely low if a property was up for sale right at the end of a tenant’s lease term, right?

EDIT: Thanks. I’ve learned a lot about cap rate. It does NOT factor in your mortgage. That being said, I saw a NNN investment for $3M, cap rate 4% cap rate ($120k NOI = $10k/month), national credit backed, publicity traded company, booming growth urban area. I used a mortgage calculator for 5% interest and it said over a 10yr loan term, monthly loan payments are $22k with 30% ($900k) down. 

If 30% (900k) down, net cash flow is -12/month // 
If 50% (1.5M) down, net cash flow is -6k/month // 
If 75% (2.25M) down, net cash flow is +2k/month // 
If 100% (3M) down, net cash flow is +10k/month // 

10k/month (120k/yr) on a 3M investment is a 4% cash on cash return. Most of my investments have been in index funds where I don’t think 4-8% annual returns is unreasonable in any given year especially when averaged over a long horizon investment period. This 4% CoC return doesn’t seem like a very good ROI. What am I missing about CRE investing? Is it the possibility that you could sell the original property at an appreciated price? Is that the main draw of CRE? There are so many CRE properties on the market right now that look pretty run down and can’t imagine that they are selling at a huge profit over what the property was several years ago. What is the big draw to CRE?
[{"id": "icalmy9", "text": "The cap rate is impacted by lease term remaining, TI &amp; leasing commission, buyer profile, deferred maintenance and leverage!\n\nSome brokers show market cap which is dumb!  In place cap rate and cap on cost tell you more.  \n\nFinding a trusting broker is so challenging!", "replies": [{"id": "icaoiby", "text": "Buyer profile has nothing to do with cap rate. The math of NOI/sale price is the same whether you, me, OP, or Bill Gates are the purchaser.", "replies": [{"id": "icdxh8v", "text": "\ud83e\udd23\ud83e\udd23 yes it does!  A 1031 buyer can pay a lower cap!  All cap rates are not the same until you understand the story behind the deal!!  You obviously don\u2019t know the industry you work in or pretend to work in!  Cost of capital and capital flows impacts cap rates aka buyer profile.  With more dumbass buyers in the market place, that pushes cap rates down! Also, cost of capital!  1031, Blackstone or institutional buyer can get more aggressive than a buyer that\u2019s conservative using base case assumptions from whatever you think is market rent growth, cap rates or expenses.  Same thing on the development side!! Groups that self perform GC and have their own balance sheet for debt and equity are winning in super competitive markets like phoenix, Austin, etc.  other players are making aggressive bets or getting lucky.  We are in the cashflow business!  Know the game or don\u2019t respond with silly responses!", "replies": [], "depth": 3}, {"id": "icjin4y", "text": "Why does grant Cardone buy only sub 3 caps?! But no one else is buying core deals?!  Every broker has a grant deal in their comp set in an OM!", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "icamh0w", "text": "You\u2019re confusing two different concepts. \u201cCap rate\u201d is just a snapshot NOI/purchase price, so basically the rate of return if the property is purchased all cash. Because of that it\u2019s not a perfect metric for most. When you\u2019re calculating the return factoring in financing, that is a \u201ccash on cash\u201d return based on after debt cash flow/your down payment.", "replies": [{"id": "icao1xz", "text": "Correct.", "replies": [{"id": "icapf31", "text": "See my above reply. Thoughts?", "replies": [{"id": "icas9ke", "text": "Okay defining cap rate as a return based on an \u201call cash\u201d purchase clarifies things and makes more sense.\"\n\nNONsense maybe.  There is no such thing as an unleveraged cap rate!  It is the same if you pay cash, finance 100% or even 125%!  Do the math.", "replies": [{"id": "iccydp0", "text": "Cap rate is equal to unlevered CoC.", "replies": [{"id": "icd066i", "text": "Ding, ding,ding!  Exactly!  There is no unlevered cap rate although so many pouesers on the internet claim there is.  \n\nAnd they use this incorrect information to trick novices.   \n\nBut if you did not correctly use direct capitalization to get your value then BOTH numbers are BS!\n\nCap rates VALUE the NOI and then you can calculate a correct CoC.  You don't calculate a CoC and then claim that is the cap rate you should be using to value the property.", "replies": [], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}, {"id": "icapdxm", "text": "Okay defining cap rate as a return based on an \u201call cash\u201d purchase clarifies things and makes more sense. But also pretty depressing. As a newer investor, I thought the cap rate was based on some regularly accepted ~30% down payment. If I am investing in a 3M property and the cap rate is 4% (120k/year, 10k/month), but instead of buying it all cash, I instead put 30% down (900k) and my monthly mortgage payments on a 10year loan (based on a tenant\u2019s current NNN lease term of 10 years) at 5% (0.05 * 2.1M = 105k/year of annual interest) for 10 years (105k * 10 = 1.05M) is $26,250 (2.1M remaining principal + 1.05M interest / 10 years / 12 months), my cash flow would be negative: 10k/monthly return (based on cap rate if paid all cash) minus 26k/monthly (mortgage after 30% down). I know some of this math is incorrect because the interest will decrease over time as my remaining loan principal decreases instead of it being consistently based off the original 2.1M principal.   But it would be true at least for the very first month into my mortgage. \n\nAll this being said, this doesn\u2019t seem like it makes financial sense for anyone unless they bought a property all cash or had the money to pay a huge down payment. How would anyone get ahead in CRE if only able to afford 30% down on a NNN property with such a low cap rate? Am I missing something?\n\nLooks like the game with CRE is not cash flow but equity. Unless of course you has the money to pay all cash and then you are getting the fully realized cap rate as your cash flow. But also are people really buying these NNN properties like 7-Elevens, national fast food chains, etc. with 3-10M all cash? Seems like there would be lost opportunity cost in putting that much money into a single project. I\u2019m lost\u2026", "replies": [{"id": "icaqvlq", "text": "You can get interest only amortization with a balloon payment at the end of your term. So your debt service decreases and you get your cash flow back.", "replies": [{"id": "icar87q", "text": "But then at the end of the loan term, you pay the remaining principal in full as a lump sum? What\u2019s the logic behind this if you\u2019re getting cash flow during amortization period but then have to save all that cash flow for the balloon payment at the end? I read most loan terms are usually for the length of years that the current NNN tenant has on their lease. So it would seem like you would be on the hook for a huge balloon lump sum in 10-15 years (average NNN lease term); or less if you\u2019re buying an NNN property at the end of their lease term.", "replies": [{"id": "icaueve", "text": "If the loan is interest only it\u2019s essentiallly a short term transitional loan that bridges you to stabilization and a permanent, amortizing loan. If all goes right you refi with a larger perm loan and use part of the proceeds to cash out some of the increased value. Or you sell the property at the higher value and pay off the loan.", "replies": [], "depth": 5}, {"id": "icav5et", "text": "&gt; But then at the end of the loan term, you pay the remaining principal in full as a lump sum? What\u2019s the logic behind this...\n\nTime value of money \n\n&gt;if you\u2019re getting cash flow during amortization period but then have to save all that cash flow for the balloon payment at the end?\n\nWhat?\n\nWhy would you \"save\" the cash flow to pay the principal? You put the cash flow to work/cover other costs/cash needs.\n\nWhen you have a monetization event (dispo/refi) you take the cash from that to pay off the remaining principal.", "replies": [{"id": "icaw1x6", "text": "If I am a first time CRE investor and this is my first property and I use this balloon strategy, where does a monetization event come from to allow me to pay the balloon at the end? I have a home but do not have much equity for any cash-out refi. So is this strategy not fit for a first time investor? Also what is \u201cdispo\u201d?", "replies": [{"id": "icax9n7", "text": "Either refi the purchased property into a standard loan at the new valuation (market appreciated), and use the cash from this to pay off the original loans outstanding principal\n\nOr\n\nYou sell the property and use some of the cash proceeds to do so.\n\nEdit: dispo = disposition, or sale of the property", "replies": [], "depth": 7}, {"id": "icl9hxp", "text": "This is 2008 territory.  If interest rates go up  (like that is going to happen you may have thought just 3 months ago)  then when the balloon is due you may not qualify at the higher mortgage rate and/or the property has decreased in value that you need to bring money to the table to refi.  That is when all that cashflow will be clawed back.", "replies": [], "depth": 7}], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}, {"id": "icarzhw", "text": "\"Okay defining cap rate as a return based on an \u201call cash\u201d purchase clarifies things and makes more sense.\"\n\nNONsense maybe.  There is no such thing as an unleveraged cap rate!  It is the same if you pay cash, finance 100% or even 125%!  Do the math.", "replies": [{"id": "icas589", "text": "Explain like I\u2019m an noob please. ?Unleveraged cap rate", "replies": [{"id": "icasd78", "text": "Cap rates tell you what other investors HAVE paid for NOI.  The formula is V=i/r.  In a 10% cap market it would be $10 and $20 in a 5% cap market.\n\nPretty simple.  The hard part is getting cap rate comps and calculating the NOI correctly.", "replies": [{"id": "icav8uy", "text": "Bruh, go away. Do we really need to have *this* fight again?", "replies": [{"id": "icavv51", "text": "Nope!  Just tell us why the seller of $100,000 NOI will take $1,000,000 at a 10% \"return\" when the seller of a 5% \"return\" gets Twice that.\n\nYou cannot do that.", "replies": [{"id": "icaw64z", "text": "Because they are completely different properties &amp; risk profiles?", "replies": [{"id": "icayqoy", "text": "Exactly!  Investors have determined that the NOI in the 5 cap market is worth twice as much NOT that they want a lower \"return\".", "replies": [], "depth": 9}, {"id": "idlq5nu", "text": "Both are Class A office CBD. \nIn Philadelphia NOI trades at a 7% cap and in SF at a 4% cap.\n\nPlease show your calculations for the different \"risk\" profiles.", "replies": [{"id": "idnlhc2", "text": "You identified it pretty clearly yourself - they are completely different properties in completely different markets. An A Class property in a completely different market is not a constant, it\u2019s relative to the inventory that is available &amp; demographics/context - demand for capital, sentiment on future development/growth, etc. \nThat is where it becomes subjective and that is why you have investors \u2018willing to pay double for NOI\u2019 as you referenced.", "replies": [{"id": "idnsd0f", "text": "Exactly!  It is not based on \"return\" because cap rates do not measure returns.  \n\nCap rates measure value and value is generally higher in high demand low supply markets.", "replies": [], "depth": 11}], "depth": 10}], "depth": 9}], "depth": 8}, {"id": "icax4tn", "text": "The use of \"return\" regarding cap rates is in relation to the ***buyer*** not the *seller*\n\nAnd as to why different properties sell at different valuations is asinine. They do so because they are valued differently by the market relative to the return investors require to own said investments.", "replies": [{"id": "icaxguw", "text": "Are you seriously saying the 10% is a \"return\" if you are talking to the buyer but the seller calls it a cap rate.\n\nThat is bizarre beyond belief.\n\nBoth sellers have a possible $100,000 NOI.  The buyers and sellers have agreed to exchange it for $1,000,000 &amp; $2,000,000.  You think the seller is taking $1,000,000 LESS so his buyer can get TWICE the return!!??", "replies": [{"id": "icay5f8", "text": "Bruh. \n\nIt is a cap rate.\n\nThey both call it a cap rate.\n\nI said; people on this sub, and within CRE in general, will casually refer to a cap rate, in relation to the buyer, as a return... I.e. you're buying the property at $100k with an in place NOI of $10k, so your cap rate (both the buyer and the seller) is 10% ***and*** for the buyer, your \"return\" on your $100k investment is 10% per annum. \n\n(Which of course is not accurate as it does not include non-operating expenses, or finance structure, or investment term, or disposition... So said more specifically, your initial operating return, based on in place NOI, on your initial investment, assuming you purchase at said price, is 10%.)\n\nBut no one feels the need to specify the above parenthetical because it is understood and implied.", "replies": [{"id": "icayv57", "text": "Only on the internet.  It is still incorrect in actual CRE circles.", "replies": [], "depth": 11}], "depth": 10}], "depth": 9}], "depth": 8}, {"id": "icbhbaj", "text": "I have no bone in this fight and not a cre investor but a stock market one interest in the sector.\n\nI feel the need to chime in that your examples completely ignore that the market is dynamic. \n\nA supposed 10% cap rate property now, with rates where they are now, would quickly find its price bid up because the noi is so good and financing cheap. That would reduce the cap rate for the buyer.\n\nThe seller doesn't get a 5% return at a higher price, their return depends on the price they paid vs. sold plus cash flow earned over the holding period. The buyer has a 5% cap rate.\n\nIt's no different from bonds or dividend paying companies. I'd love to magically say my yield is lower because that means the price is higher when I sell, but I don't get to choose the price someone is willing to pay. I only get to choose what I pay to buy or agree to sell.", "replies": [{"id": "icbzden", "text": "You stated, \"It's no different from bonds or dividend paying companies.\"\n\nBonds don't have capex, vacancy, etc.  NOI is not a dividend.  You have non operating expenses", "replies": [{"id": "icc3u3f", "text": "You're nitpicking, and I wasn't clear enough. \n\nOf course they are different but we are talking yields and in that more general regard it's the same (read similar if you need to).\n\nIf I pay less, my yield is higher for a given income and vice versa. Same with cap rates.\n\nIt doesn't magically make a property price higher, per your hypothetical example.\n\nI have to take the price the market determines, and based on a give yield or NOI, that's the cap rate.\n\nI can't just wish a lower cap rate and make my sale price higher.", "replies": [{"id": "icc7z1h", "text": "\"If I pay less, my yield is higher for a given income and vice versa. Same with cap rates.\"\n\nThat would only possibly be true if you paid $10 for NOI in a $12 market.\n\nIf you are paying $10 for NOI in say Detroit vs. paying $20 for NOI in say San Francisco you cannot say which property has a higher \"return\" \"yield\" or whatever you want to incorrectly call the valuation metric that is a capitalization rate.", "replies": [], "depth": 11}, {"id": "icc8cxl", "text": "\"I can't just wish a lower cap rate and make my sale price higher\".\n\nBut you seem to be saying you can control your \"yield\" by buying in markets that investors pay less for NOI.", "replies": [], "depth": 11}], "depth": 10}], "depth": 9}], "depth": 8}], "depth": 7}, {"id": "icawexs", "text": "Then please clarify.  PROVE ME WRONG.  I will wait patiently. \n\nOP, don't listen to anyone that can't clearly answer a question or try to bully you.  Best to ignore them at that point.", "replies": [], "depth": 7}, {"id": "icawofd", "text": "Then please clarify.  PROVE ME WRONG.  I will wait patiently. \n\nOP, don't listen to anyone that can't clearly answer a question or try to bully you.  Best to ignore them at that point.", "replies": [], "depth": 7}, {"id": "icawuy5", "text": "Quit acting unprofessional and show the OP where I am incorrect....if you can.", "replies": [{"id": "icbd34b", "text": "Mods? Assistance please?", "replies": [], "depth": 8}], "depth": 7}], "depth": 6}], "depth": 5}, {"id": "icavcj8", "text": "Don't listen to him OP, we have had many arguments with this guy on the sub. He has very strong principled beliefs about what things mean, but the practical difference, and industry standard, makes his point of view irrelevant.", "replies": [{"id": "icaw6vg", "text": "Then please clarify.  PROVE ME WRONG.  I will wait patiently. \n\nOP, don't listen to anyone that can't clearly answer a question or try to bully you.  Best to ignore them at that point.", "replies": [{"id": "icawxzk", "text": "I really don't want to hash it out again. We did this like 6 months ago. \n\nYou have an ideological pathology to view cap rates from a certain lense. That's fine. More power to you. But, your insistence on using this sub as a platform to spread that viewpoint while being caustic, antagonistic, and down right disruptive to the community is just atrocious behavior.\n\nUltimately, the CRE community views cap rates as a suitable metric to use in evaluations while comparing acquisition opportunities, evaluating markets, speaking about trends.\n\nDoes leverage alter returns therefore making a cap rate on a property an incomplete picture? Sure! But what do I care if my financing terms allow me to purchase any investment I want? Now my financing is static in the equation and no longer relevant (when comparing opportunities).\n\nOf course my financing terms are relevant when underwriting a deal and at that point when speaking about that deal I would look at proforma irr and multiple.\n\nBut to come on this sub and rail against people who explains to a new person the general idea of a cap rate as:  \"hey if that property makes $10k/yr in NOI, and you bought it today at $100k, it would have a 10% cap rate or return ( a 10% unlevered operating return in your first year based on in place noi).\" As somehow wrong and (almost) morally reprehensible to you is just... Well, a bit crazy tbh.\n\nSo yeah, as stated before.\n\nBruh, do we really need to do *this* again?", "replies": [{"id": "icaxz5c", "text": "Then act professional and leave the OP and me alone.  It is you jumping in here misbehaving.\n\nAnd I NEVER said if you paid $100,000 for $10,000 NOI that you did not create a 10% cap rate!  I just factually showed you how you overpaid.  Geez, get a grip.\n\nHappy to have you post incorrect information.  The facts prove you to be incorrect.  LOL. Have at ir.", "replies": [], "depth": 8}], "depth": 7}], "depth": 6}], "depth": 5}], "depth": 4}, {"id": "icbcuql", "text": "OMFG....I knew he'd show up.\n\nHeyDoc...pretend this guy (Honobob) has just ingested 11 hits of the best LSD on the planet and is tripping (it's *entirely* likely I may be prophetic).\n\nDo not listen to *anything* he says.\n\nDo not stand anywhere near him.\n\nDo not associate with his friends.\n\n***QUICKLY*** find a necklace made of garlic and carry a wooden stake and a mallet with you at all times.\n\nYou would do better to buy a small 12,000 sf warehouse from a con man for 30 trillion dollars in cash, with no title or deed, than to ever listen to any advice he has to offer.\n\nYou literally threw out his cat nip: Cap rates.  He'll follow you to the ends of the Earth now.\n\nRun, do not walk. Get the fuck away from this guy.", "replies": [{"id": "icedwlp", "text": "Lol I think I\u2019m going to enjoy this subreddit.", "replies": [{"id": "icens4l", "text": "Only if you enjoy wading through low input trolls.  It is a shame this happens.  Nothing wrong with lively debate but when one side adds nothing but ignorant shrieks it can become tiresom.", "replies": [{"id": "icfrgwc", "text": "&gt;but when one side adds nothing but ignorant shrieks it can become tiresom.\n\nHence the various and multiple warnings from multiple posters about your comments.\n\nExcellent point Honobob.\n\n(And...it's tiresom:::***e:::***).", "replies": [{"id": "icgj6yv", "text": "List'n more.\nhttps://m.youtube.com/watch?v=hH4wH0e4SDE", "replies": [], "depth": 8}], "depth": 7}], "depth": 6}], "depth": 5}, {"id": "ig7f49m", "text": "https://m.youtube.com/shorts/j-NZpDAag98", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}, {"id": "icaumf4", "text": "You would have a ten year term, but the amortization would still be over 20 years, so the 26k/month payment in your assumption would be wrong and it wouldn\u2019t be as horrible of an investment. Still horrible, just not as much so \n\nSTNL deals already trend more to the institutional buyers who can pay cash or the 1031 market for a reason- even when interest rates were in the 3\u2019s and 4\u2019s you would basically be trading money with your bank by financing the lower cap deals and now you\u2019d be losing money", "replies": [{"id": "icawi4n", "text": "I have a very basic understanding of mortgages and loans. How can you have a 10 year term but 20 year amortization? When is the full balance of the loan+interest paid.. at 10 years or 20 years? If you have 20 year amortization schedule, what happens at year 10 of your term? You renew the contract for another 10 years and keep paying along the same 20 year amortization schedule until it\u2019s all fully paid off at the end of your 2nd 10 year term? This would be much better than the original 10 year term/amortization schedule I first assumed. What is the most common amortization schedule for CRE NNN loans? Is this what people mean when they say they have a 10 year loan on a 20 year note?", "replies": [{"id": "icaxknp", "text": "5/20 or 10/20 is pretty vanilla financing. Multi-family properties can get longer amortization. Sitting down with a lender to discuss financing options is probably a good early step for you to get familiar with what you\u2019d be getting into", "replies": [], "depth": 5}], "depth": 4}, {"id": "icaxnlu", "text": "Did some reading on loan terms and longer amortization schedules. It said it\u2019s good for those who cannot afford a large down payment and high monthly payments. But at the end of the loan term, many pay a balloon payment for the full amount remaining. If one can\u2019t afford a big down payment nor big monthly payments, how can one afford to pay off half the entire loan in a big lump sum in 10 years (20 year amortization)?", "replies": [{"id": "icaxujv", "text": "That\u2019s not your money paying off the balance when the loan terms out. You refinance", "replies": [{"id": "icazopk", "text": "What\u2019s your CRE portfolio look like? How long have you been doing it? Seems like you have a good handle on it.", "replies": [{"id": "icbgfxu", "text": "I\u2019ve been a broker for 12 years by trade and just started on the ownership side 5 years ago partnering 20-25% on deals with a couple good clients. We started with value add multi-tenant retail but then bought a stabilized STNL flex building a couple years ago so kinda all over the board", "replies": [{"id": "icbjn9y", "text": "What region? What\u2019s the best way to find a good reputable local broker that I can trust and work with long term? There are wayyyyy too many and they all say they can fit the bill.", "replies": [], "depth": 8}], "depth": 7}], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}, {"id": "icdk8oq", "text": "No one \u201cgets started\u201d in real estate on 30% down NNN deals.\n\nNow you understand why!\n\nThe reason investors do these deals is because they are exchanging out of a highly appreciated asset and they need something low-key to roll the money into to avoid paying taxes. So, a low LTV is the starting point.\n\nOr, they do the ground up development and tenant placement, so they can sell to the buyer described above.\n\nThat\u2019s it. That\u2019s the only use case.\n\nIf you\u2019re \u201cstarting out,\u201d then you should look at other deal types and structures where you can add more sweat and make higher returns.", "replies": [{"id": "icedhjj", "text": "Very interesting. I get it. Any recs on other deal types and structures that may be better for someone in my position? The NNN structure was attractive because I like passive investment strategies. I have an active full time W2 that I would hopefully like to phase out of.", "replies": [{"id": "icedvq9", "text": "You pick your poison. Passive and low returns or active and high return. If you want to be passive with your current bank roll do REITs.", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "icansa7", "text": "Debt service is not an operating (the O in NOI) expense.", "replies": [], "depth": 1}, {"id": "icapuwy", "text": "So the NOI is net operating income, which is gross rents less the expenses to operate the property (think taxes, insurance, maintenance, management,  utilities, etc). \n\nThings like interest expense and depreciation are not included in the NOI calculation and in most scenarios non recurring income/expenses are also not calculated in the NOI.\n\nThe NNN can be defined in a number of ways but basically means the tenant is responsible for the taxes, insurance, maintenance, etc, which is also stated as the common area maintenance or CAM expenses. To use a McDonald's location for example,  the franchisee pays McDonald's rent and is responsible for everything that needs to be replaced like flooring, paint, roofing, electrical,  etc, whereas McDonald's owns the land, concrete, wall studs, etc or items that don't really need replacing. \n\nThe lower the cap rate means a stronger property in terms of rental income and credit tenants. So think of it like investing your money in treasuries that are backed by the US government vs corporate bonds of a mid tier company. The likelihood of a default of the Government is highly unlikely, there for the returns are less.\n\nHope this helps.", "replies": [{"id": "icaqhrh", "text": "Cap rates are a value metric not a return metric.", "replies": [{"id": "icaqtmd", "text": "I like that. That\u2019s a handy way of putting it.", "replies": [], "depth": 3}, {"id": "icaqu5r", "text": "I would disagree with you, as they are both. If you have a property with $100M in NOI and a purchase price of $1MM, you have a 10% Cap rate or 10% return if you invested $1MM and purchased the property outright.", "replies": [{"id": "icar8rw", "text": "Where are you getting your \"purchase price\"?", "replies": [{"id": "icas26d", "text": "The purchase price is based on what ever the seller is asking. Now the question becomes is that a reasonable amount based on previous sales on similar properties,  which is where the income approach in the appraisal will either support the value or not. \n\nSo if you have a comparable property(ies) that are operating at a 10% cap (NOI/sales price) and you go and list your building at an 8% cap, or $250M more than market, it more than likely won't sell unless you have a premium product or a reason to support the lower cap rate (meaning the property is in theory a better property with less return resulting in a \"safer\" investment).", "replies": [{"id": "icaswr0", "text": "OK, it sounds like you understand the Value part but where does the \"return \" come in based on cap rate?  It doesn't!  Use cap rates to Value THEN use actual return metrics like CoC, etc.", "replies": [], "depth": 6}], "depth": 5}], "depth": 4}, {"id": "icddjqy", "text": "I wish I could find a property with those numbers....", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "icaq0uc", "text": "Advertised cap just tells you what the seller wants YOU to pay him for each possible dollar of NOI.\n\nA 10% cap means he wants $10.  A 5% cap means he wants $20.  The property does not have a cap rate until it is sold.  If you buy $100,000 NOI at a 10% cap rate you pay $1,000,000.  But if similar properties have sold at a 12% cap rate then you overpaid. The $1,000,000 you paid for $100,000 NOI was really only worth $833,333.  \n\nCap rates measure value not return.", "replies": [{"id": "icar97o", "text": "\u201cHey I have this vacant building but I worked up a proforma cap\u201d", "replies": [{"id": "icarnw4", "text": "I'd sure like to see the math on that because I think that is impossible.", "replies": [], "depth": 3}], "depth": 2}, {"id": "icas112", "text": "I am digesting this reply even after a few reads but it makes a bit more sense since I am in the medical field where often medical practices are bought by private equity firms at some multiple of their EBIDTA (or cash flow). \n\nWhat\u2019s the best way to determine what a good cap rate (or the amount a seller wants you to pay for a certain NOI) is? Googling seems to say 4-10% is \u201cgood,\u201d lower the cap rate, lower the risk, vice versa. But that\u2019s a huge range. Is 3-4% for Starbucks good? What about 5.5% for IHOP? 6.5% for 7-Eleven? They all seem like reliable national credit backed businesses but these are some of the rates I\u2019ve seen in an area I was searching through. No clue why the difference.", "replies": [{"id": "icatd50", "text": "There is no such thing as a good cap rate.\n\nYou either buy at what other investors are paying or above or below.  If NOI is selling for $10 and you buy at $11 did you overpay or is the market changing.  Same thing if you pay $9.", "replies": [], "depth": 3}, {"id": "icb74ty", "text": "Cap rates mirror local market factors. If it is a fully leased building in a prime market and everyone believes it will be a stable property with consistent income then the cap rate is low.  If you\u2019re buying a hotel in a market where the economy occasionally craters like say in the oil business\u2026then there is less consistency and it will trade at a higher cap rate.  What that higher cap rate should mean is higher risk. Does that make more sense?  Low cap rates usually occur in very stable upscale markets.  Can you earn good money buying low cap rate properties? Sure but you gotta raise the rents! See how it works?", "replies": [], "depth": 3}, {"id": "icbd88b", "text": "&gt;What\u2019s the best way to determine what a good cap rate\n\nBy taking anyone's advice other than Honobob's.", "replies": [], "depth": 3}, {"id": "icdjr6k", "text": "Thinking in terms of multiples is a good analogy. Cap rate is really just the EBITDA multiple that someone is willing to buy a real estate asset at\u2014except instead of EBIDTA it\u2019s NOI and expressed as a percentage.", "replies": [], "depth": 3}], "depth": 2}, {"id": "icawc4b", "text": "I work in finance - we very much assign cap rates prior to sale\u2026.as we need to ascertain the value of the property, stabilized, at NOI. Depending on asset, lease terms, and comparables, etc.", "replies": [{"id": "icc0lnx", "text": "And you would be getting that cap rate from cap rate comps not working up a proforma CAP RATE.  You would work up a proforma NOI.  Then use market cap information to get your value.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "icaqyt9", "text": "https://www.reddit.com/r/CommercialRealEstate/comments/vaqe2r/new_investor_cap_rate_of_10_looking_for_some/  \n\nCheck this recent thread on cap rates.", "replies": [], "depth": 1}, {"id": "icas76s", "text": "Okay defining cap rate as a return based on an \u201call cash\u201d purchase clarifies things and makes more sense.\"\n\nNONsense maybe.  There is no such thing as an unleveraged cap rate!  It is the same if you pay cash, finance 100% or even 125%!  Do the math.", "replies": [], "depth": 1}, {"id": "icastxh", "text": "Just think of it as cap rate is per-debt meaning debt service is not included in its calculation of NOI/property value. NOI is basically gross effective rent - OPEX (excluding mortgage payments which is debt service) therefore cap rate does not change as your leverage changes", "replies": [{"id": "icatqra", "text": "What do you mean by \u201cyour leverage\u201d?", "replies": [{"id": "icauk3c", "text": "Your loan to value ratio. Basically how much you put down versus how much you\u2019re borrowing. Or the other way around, either way.", "replies": [{"id": "icawv6s", "text": "Trying to understand how the term is used because I hear it all the time when I\u2019m reading about CRE but I\u2019ve only used it in terms of negotiating with an employer (eg. having more leverage to negotiate a better salary). If I put more down, does that mean I have \u201cmore leverage?\u201d Or is the term used from the perspective of the bank? Someone replied earlier and used the term \u201cunleveraged.\u201d Does that mean doing 0% down payment?", "replies": [{"id": "icayqil", "text": "More debt (higher LTV) means more leverage. Debt financing is leverage in finance nomenclature.", "replies": [], "depth": 5}, {"id": "icazthp", "text": "Person above is on point. Unleveraged means you\u2019re not taking on debt so no leverage at all.", "replies": [], "depth": 5}, {"id": "icbtwy8", "text": "Ask fewer questions.  Read more.", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "icau1vi", "text": "Lots of information and a bit confusing for some people.\n\nTo simplify:\n\n1)Cap Rates = NOI / Market Value (Purchase Price) ; this is a measure to compare the rate or return on multiple commercial properties.\n\nEx: 300,000/3,000,000 = 10%\n\n2) Cap Rates will NOT provide a Return On Investment (IRR).  Each investor has its own IRR depending how the financing is done for the acquisition : all cash or cash+debt/finance\n\n3) If an investor will purchase the property with debt , then the lender will have its own internal assessment of the investment ( some factors for lenders: vacancies, deferred capital projects , assessed value etc)\n\n4) NNN = this is a triplet net lease where the tenants pay the base rent + Operating expenses. Base rent goes to the landlord , operating expenses are paid by the LL and charged by to the tenants through CAM\n\n5) A property with a higher cap rate is a property with a higher risk\n\n6) Also , the property might appreciate in value over a period of time, therefore increasing the rate of return for the investor.", "replies": [], "depth": 1}, {"id": "icbob5r", "text": "It sounds like you could benefit from taking a class on this topic. It\u2019s a lot to piece together from information on Reddit. Income Capitalization classes that are geared toward appraisers would cover most of the questions you\u2019re asking and might be able to give you the \u201cbig picture\u201d you\u2019re looking for. Cap rates are highly variable based on location, tenant, lease terms, etc. Check out Boulder Group\u2019s research section on their website, they publish data on cap rates and may help you to understand \u201caverage\u201d cap rates for Starbucks vs. Dunkin\u2019, etc.  Marcus and Millichap is a good resource for NNN listings, with prominently displayed cap rates. Don\u2019t waste your time on Loopnet if your just trying to understand cap rates, there\u2019s way to much info to sift through.", "replies": [], "depth": 1}, {"id": "icc0j6u", "text": "Glad people are coming here for advice but....the more of these posts I see the more \"hey, there's a bubble\" I feel", "replies": [], "depth": 1}, {"id": "icc0ouk", "text": "&gt;This 4% CoC return doesn\u2019t seem like a very good ROI. What am I missing about CRE investing?\n\nSome buildings do not offer a very good rate of return, but are often very stable assets bought by funds that are ok with a low but stable return.\n\nReturns include more than annual cash flow. Properties can potentially appreciate in value, you can accrue equity as the mortgage is paid down unless it's an interest only loan. Rents can potentially be increased, or expenses reduced over time. There are tax advantages such as depreciation.", "replies": [], "depth": 1}, {"id": "icc2j2b", "text": "Cap rates on quality NNN's have compressed since the pandemic started.\n\nHard to cash flow with current interest rates if you plan on financing the purchase.", "replies": [], "depth": 1}, {"id": "icc34f8", "text": "The draw is that you own a hard asset and you can\u2019t touch and feel a fund", "replies": [], "depth": 1}]