The income approach to VALUE Cap Rates explained! Questions?
S[**F\_Lady**](https://www.reddit.com/user/SF_Lady/)**·**[**5 mo. ago**](https://www.reddit.com/r/CommercialRealEstate/comments/qp2q7a/comment/hk9dsdj/?utm_source=reddit&amp;utm_medium=web2x&amp;context=3)**Banker**

**You keep saying the definition I provided from investopedia is incorrect, which I firmly believe is 100% accurate based upon way too much experience and reviewing way too many appraisals, so that equates to you telling me I’m wrong. I’d like to understand how/why.**

**You seem confident that your version of calculating cap rates is better. I’d like to learn your point of view.**

I am confident.  This is the incorrect definition of calling a cap rate a "return".

[Capitalization Rate Definition (investopedia.com)](https://www.investopedia.com/terms/c/capitalizationrate.asp)

&amp;#x200B;

Now Investopedia says it is a valuation metric.

[Income Approach Definition (investopedia.com)](https://www.investopedia.com/terms/i/income-approach.asp)

&amp;#x200B;

1. The formula is V=i/r
2. $10=$1/10%
3. $20=$1/5%

All the cap rate tells you is what investors have paid for NOI.  Here in one market they paid $10 and in another $20.  There is a value there.  There is no "returns"

&amp;#x200B;

Questons?
[{"id": "i35tcl2", "text": "*Heeeeeee's baaaaaaaack.*\n\nMods? Dude has ingested another bowl of shrooms and is back on the Cap rate war path again. Check out his comments history...he's got some kind of Tourettes thing going on with cap rates.  He can't let the shit go.\n\nWhere's Wavy Gravy...maybe he knows how to talk the dude down?\n\nWhere ya been dude? Betty Ford Center for cap rate addicts?", "replies": [{"id": "i366ypa", "text": "Wavy gravy \ud83d\ude2d - he would 1000% talk him down", "replies": [], "depth": 2}], "depth": 1}, {"id": "i35vfeo", "text": "Would say mods should ban this at this point...regardless\n\nOne simple way to look at the correlation with returns would simply be to suppose the world would play out exactly the same after the purchase occurs regardless of what an investor paid for the NOI off of asset A. So we have two scenarios - scenario I (investors purchased asset A and you calculate a 5 cap), scenario II (investors purchased asset A and you calculate a 3 cap). In both scenarios, ten years down the line, asset A has shown the same cash flow and is now worth the same amount in both scenarios if the investor would choose to sell.\n\n In which scenario now would the investor show a higher return, ceteris paribus? As a result of the clear answer (scenario I), there's some correlation there. The cap rate is not, of course, solely a 'return' metric and is closer/more akin to an 'earnings yield' concept in equities, but there is some positive correlation with the level of return one expects to make.", "replies": [{"id": "i35xwu1", "text": "&gt;In which scenario now would the investor show a higher return, \n\nThe cash flow even if the same does not tell you the \"return\" or the profitability.  Geez, this is way out there.", "replies": [{"id": "i35yctu", "text": "In what world does paying less for an asset with the same cash flows not imply a higher return? Just basic present value analysis ...", "replies": [{"id": "i35zafr", "text": "What are you calling \"cash flow\", NOI?  NOI is not a return metric.  Higher cash flow (NOI) does not mean higher returns.", "replies": [{"id": "i35zj1m", "text": "Any and all cash flows - assume the world and all the cash coming into the property and all expenses are exactly the same. As a result, NOI, NCF, NOPAT etc all of it will be the same in both scenarios. The only difference - what you paid for the asset.", "replies": [{"id": "i3607ou", "text": "&gt;and all expenses are exactly the same\n\nWell that changes things, a bit.  What if one market is declining in value, in other words the cap rate is rising in that market but in the similar property the cap rates are compressing?", "replies": [{"id": "i360hn6", "text": "Seems you didn't read my initial message - the world ends up the same. It's the same asset. The only difference is what was paid.", "replies": [{"id": "i361yaw", "text": "That still doesn't have anything to do with the cap rate.  Sure, if Grandma sells you for less than market value you MIGHT be able to squeek out a higher \"return\".  \n\nCap rates do not measure \"returns\".  Buying under market MIGHT get you a higher return.", "replies": [{"id": "i362cxe", "text": "Investors paying less for the same cash flows and as a result, getting a good price (higher imputed cap), has nothing to do with your expected return? Yeah... I think you're pulling my leg at this point. Buying \"under market\" in our scenario I've set out here does exactly that. Nets you a higher return.", "replies": [{"id": "i364k34", "text": "Buying under market does not guarantee better returns.  And the cap rate although higher does not measure the return.", "replies": [{"id": "i364mld", "text": "If the future cash flows are the exact same, (- AS LAID OUT IN THE FIRST COMMENT-), it does.\n\nEdit: I'm really not sure where you're struggling. Maybe reread my initial comment and it will become clear. We have just walked through a simple analysis where a higher imputed cap does exactly imply a higher return. Scenario I investors *will* have a higher return than scenario II investors, ceteris paribus.", "replies": [{"id": "i365zfp", "text": "Again, you are struggling because you are not following the thread.  A 10 cap market is not more profitable than a 5 cap market.  Cap rates measure VALUE not RETURNS.  That is it!  Do you want to comment on that?", "replies": [{"id": "i366483", "text": "But it is - in the exact scenario I have defined. Do you disagree? In the situation I gave, a higher cap rate will correlate with the higher return scenario. Grab a calculator, do it in excel.", "replies": [{"id": "i366qpr", "text": "Not at all.  If I buy at a 5.5 cap rate I'm paying $18.18 for a dollar of possible NOI.  If I buy at a 5.8% cap rate I am paying $17.24 for a possible dollar of NOI.  You would think paying less would get a higher return and it peobably does but the cap rate does NOT measure the \"return\".", "replies": [{"id": "i366xuw", "text": "I didn't say cap rates directly measure returns - cap rates are *correlated* with returns. To be clear though, in my scenario, paying less *would* definitively imply a higher return.\n\nTo the extent you're not just fooling around, DM me your number and I'll call you and explain the concept if you're struggling", "replies": [{"id": "i367o7r", "text": "Cap rates not being a \"return\" metric is the point of the thread.  Cap rates CAN be indicative of returns but that is all.  Seems you agree that cap rates do not measure returns.  I can answer any valuation question you have.  Feel free to ask.", "replies": [{"id": "i368nee", "text": "Your argument is that, \"yes, cap rates indicate returns, but shouldn't be called a return metric?\" I mean.. who cares? So long as everyone agrees they're positively correlated w/ returns...\n\nBut, I did need some valuation help so I will take you up on that - seems you're an *expert*, so you should be able to help me with simple theory around vanilla securities. Suppose you're modeling the price of an option subject to BSM, but you're interested in determing the value using some stochastic interest rate model (Gauss+, CIR, Ho-Lee, etc), what do you think are the relative benefits of doing this versus the additional complexity?\n\nSeeing as you're the pro, you should be able to help me out here.\n\n&amp;#x200B;\n\nEdit: Maybe you say \"Hey! I'm only the expert in CRE valuations\" -  Let's stay in CRE then, you've got an asset that will pay $3 next year, increasing at a rate of 3% per year for the next 40 years, and then will end with 0 salvage value. What's the formula to calculate the PV of the increasing annuity? This is a college freshman-level valuations question.", "replies": [{"id": "i36an5h", "text": "The thread is about cap rates being a valuation metric from an income approach to value called direct capitalization. \n\nIf you want to start your own thread on PV you might want to state when the $3 payment is being made.  Makes a huge difference.", "replies": [{"id": "i36azfh", "text": "Exactly one year from today. You're the expert, what's the calc?\n\nI don't understand why you're pretending to know more than you do dude - I tried to help,  you can't answer a simple valuation question cause you don't understand the basics. Can DM me and we can chat on the phone or you can continue to play games.", "replies": [{"id": "i36bf21", "text": "Please DM me your phone number.  You are trying to hijack my thead.  I'll call you if I need help.  MEANWHILE, you agree that cap rates do not measure \"returns\"?  That is the thread.", "replies": [{"id": "i36bzfj", "text": "The formula for the asset would just be subtracting two infinite lived perpetuities from each other. D1/r - ((D41)/r)/(1+r)\\^41. \n\nYou would fail an intro valuations course. \n\nAlso, you ended the initial post with \"There is no 'returns'\" - Yet, you now do agree cap rates are correlated to returns. So, yes *you* do agree, there is some concept of \"returns\" related to cap rates.", "replies": [{"id": "i36cjwt", "text": "No!  NO1! NO!  I said cap rates CAN be indicative of \"returns\" such as if investors are paying $20 for a dollar of NOI then they are expecting greater returns than some novice investor paying $10 for NOI.  See, EXACTLY the opposite of what you are incorrectly saying.", "replies": [{"id": "i36crx2", "text": "Best of luck man - I hope I'm on the opposite end of every one of your transactions", "replies": [{"id": "i36e65g", "text": "So?", "replies": [], "depth": 24}], "depth": 23}], "depth": 22}], "depth": 21}], "depth": 20}], "depth": 19}], "depth": 18}], "depth": 17}], "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}, {"id": "i9pmio5", "text": "\"In both scenarios, ten years down the line, asset A has shown the same cash flow and is now worth the same amount in both scenarios if the investor would choose to sell.\"\n\nWhy, why why would you think that NOI that was only worth $20 (5% cap rate) suddenly become worth $33.33?!  (3% cap rate)", "replies": [], "depth": 2}, {"id": "igoxbq8", "text": "https://m.youtube.com/shorts/j-NZpDAag98", "replies": [{"id": "igssezz", "text": "He's wrong, pretty simple", "replies": [{"id": "igt0wfa", "text": "Yet the math supports his conclusion.", "replies": [{"id": "igt71qm", "text": "It doesn't -  you and I have already gone through this and you weren't able to decompose a cap rate into its component parts", "replies": [{"id": "igt9bw4", "text": "Dude, it's just IRV. R=I/V.  WHAT PART OF THAT DON'T YOU GRASP?", "replies": [{"id": "igtbnqh", "text": "If you wanted to decompose R, how would you do it?\n\n&amp;#x200B;\n\nYou seem to have failed calc 2...the cap rate formula was derived through a simple geometric series...if you cannot derive it, don't act like you understand it", "replies": [{"id": "igtiynl", "text": "1.  Duh, why do you want to decompose  R?\n\n2.  The cap rate formula is r=i/V.  Just find out what sellers have paid for NOI.  Adjust accordingly.  \n\n3.  Why/how would a typical buyer try to derive a cap rate.\n\n4.  So simple a caveman could do it but you want to jumble it up so you look intelligent.\n\n5.  It ain't working.", "replies": [{"id": "igtknlt", "text": "The cap rate formula can be decomposed - and you have an inability to do it. You decompose a figure to see what causes it to move\n\n&amp;#x200B;\n\nWalk me through the math then come back to me, we've had the convo before and you couldn't do it before and chose not to learn. The fact that you think calc 2 is in any way complex is embarassing", "replies": [{"id": "igtmz0i", "text": "Cap rates come from an income approach to VALUE called direct capitalization.   \n\nIt is used to determine the probable current value of NOI.  \n\nYour \"decomposing\"  is not going to change today's cap rate.  Quit acting like there is some magical way to determine changes in cap rates.  \n\nAnd this has nothing to do with valuing NOI.   You are just trying to make something seem complicated.\n\nBut yes,  learn me your useless figgering.  You have my attention.", "replies": [{"id": "igtn6d3", "text": "I have already told you how to do it...it's a geometric series...??? How do you not know this lol", "replies": [{"id": "igtpgir", "text": "I must have missed it.  Please repost.\nI like geometric series.\nPS  the whole point of this thread was to correctly identify cap rate as a valuation metric and not a measure of risk or return.  \n\nI don't understand your attempt to derail the discussion but since you have, show me the figgering!", "replies": [{"id": "igttgw1", "text": "I am not helping you *again* with a high school math problem\n\n&amp;#x200B;\n\nYou do not realize what determines movements in what people are willing to pay for a dollar of NOI and that is why you do not understand cap rates and can not decompose them mathematically", "replies": [{"id": "igtusop", "text": "I'm calling BS.  Either you can provide figgerin or not.  Lazy, just cut and paste.\n\nBut, before you waste more time it is just supply and demand that moves cap rates.  How can you not know this?", "replies": [{"id": "igtxqq9", "text": "call bs then, it's your loss mate, google \"how to solve a geometric series\" or 'geometric series proof\"\n\n&amp;#x200B;\n\nif you can't learn high school math, that's your problem - and again, what drives demand? why would something have more demand? perhaps....because the hurdle rate has gone up as interest rates have risen....because that is a key component of the formula...which you cannot solve for, because you cannot do high school math\n\n&amp;#x200B;\n\n\"The math supports his conclusion\" - The exact math you are too inept to do", "replies": [{"id": "igu78zu", "text": "OK you are just talking g gibberish throwing in random words you probably got from a guru seminar that you paid $10,000 on your credit card.\n\nI'm obviously not missing anything because you cannot explain your high school math.  Geez.", "replies": [{"id": "iguw5nq", "text": "if you think you had to pay $10 to take a course in high school...you had a pretty shit education lol", "replies": [], "depth": 17}], "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": "i364be5", "text": "If there is no growth or leverage, cap rate = IRR = yield = ROI = ROE", "replies": [{"id": "i365mcg", "text": "IF?  Cap rates do not measure \"returns\".", "replies": [], "depth": 2}], "depth": 1}, {"id": "i36c9lu", "text": "If I put in $10MM and made $1MM for 9yrs and on the 10th year, I sold for $11MM \u2014 my return is higher than the person who pays $10MM and makes $500k for 9yrs and sold for $10.5MM in year 10.", "replies": [{"id": "i36e0l8", "text": "So?", "replies": [{"id": "i36fzai", "text": "10% cap v 5% cap", "replies": [{"id": "i36s68a", "text": "\n\nK   in one market NOI is selling for $10 and in another it is selling for $20.\n\n&amp;#x200B;\n\ndo you have a point?", "replies": [{"id": "i37u044", "text": "I\u2019ll buy the one where I make 2x v the other one. K", "replies": [{"id": "i8r8lk6", "text": "That is NOT what the cap rate is telling you.  It is telling you that investors only value NOI at $10 in a ten cap market and $20 in a 5% cap rate market.  See how you were misled?", "replies": [{"id": "i8r9fpc", "text": "I\u2019ll buy the one where I make 2x v the other one. K", "replies": [{"id": "i8usuva", "text": "That could be the 5 cap. K?", "replies": [{"id": "ia9ey6s", "text": "How\u2019s that 5% treating you with these interest rates?", "replies": [{"id": "ia9kpq4", "text": "Fantastic!  Because of FOMO my properties could sell at a 4% cap rate so my NOI is worth 25% more!!!  $20=$1/5%  And $25=$1/4% !!!!! Let the novices and suckers buy 10% crap.  LOL", "replies": [{"id": "ia9ld4c", "text": "Lol", "replies": [{"id": "ia9ntaj", "text": "LOL all the way to the bank!  Now I'm guessing that not only were you bamboozled into thinking a cap rate was a \"return\" but you have also been fooled into thinking there is a direct correlation between mortgage rates and cap rates! Amirite?  But think about this.  Interest rates are pretty much the same throughout the country but the difference in cap rates vary greatly.  Now if you foolishly believe the  \"spread\" is your profitability then have at it buying Detroit crap.", "replies": [{"id": "iae3cu6", "text": "I hate FCF. It\u2019s just the worst, amirite?", "replies": [{"id": "iae5ms3", "text": "Why?  If you know how to calculate it can show you why a 5% cap rate can be more profitable than a 10% cap.", "replies": [], "depth": 14}, {"id": "ibaj0n8", "text": "Hey, didn't mean to scare you off.  Did you want to discuss FCF or are you just throwing crap out there?", "replies": [], "depth": 14}, {"id": "igoxirf", "text": "https://m.youtube.com/shorts/j-NZpDAag98", "replies": [], "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": "i37hycx", "text": "Ellwood and Ackerson.\n\nCap rates are from the time before computers.  The formula takes into account changes in income and appreciation, as well as yield to debt and equity.  Whole books of tables were printed based on permutations. \n\nThe bigger problem in few in CRE today can forecast anything.  Hence, everything is simplified into accounting and no matter what the formula, critical variables are irrationally used.", "replies": [], "depth": 1}, {"id": "i37mrrl", "text": "Jesus Fucking Christ !!!!!!!!!!!!\n\nWhat the fuck is wrong with you Honobob ???\n\nWe had a private conversation that lasted from Nov 19 - Dec 29.\n\nPages and pages of text were sent back and forth, trying to put this to rest once and for all.\n\nI thought it was done.  \n\nI thought we came to a conclusion ..... and yet here we are, new year, same weird fascination with cap rates.\n\nBefore we ban you, can you simply drop this cap rate conversation ... it's a dead end for you and the sub.\n\nYou had solid posts in R/realestateinvesting years ago, until you dipped your toe in cap rate land and you've never stopped since.\n\nedit -   So what do you say Honobob, are you ready to drop this once and for all or do you want to be banned for good ???", "replies": [{"id": "i37owuc", "text": "It will never be done.", "replies": [{"id": "i37p7tc", "text": "Then he'll be banned for good.", "replies": [{"id": "i38cvyc", "text": "There is hope.", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}, {"id": "i38cgp8", "text": "He is to an extent correct.  The definition he cites is simple. No discussion of j or k factors,  which today are critical to forecasting a realistic terminal rate even in Argus.  People who use simplistic going in rates and a 50 basis point premium for the terminal rate are not being realistic about interest rates.", "replies": [{"id": "i38kfhs", "text": "&gt;He is to an extent correct.  The definition he cites is simple.\n\nThe definition was given by SFLady.  I merely pointed out that it was incorrect.  I did provide a discussion from the same source that correctly describes the use of cap rates as a valuation metric.\n\nCap rates are simple.  V=i/r   A 6.385% cap rate means that the investor paid $15.66  per dollar of possible NOI.  Easy peasy!  Now the hard part would be the decision of buying in a 6.385% market or a 9% market.  That is where the discussion should be once you realize that the cap rate just tells you the VALUE of the NOI.", "replies": [{"id": "i395ojj", "text": "That is the simplest understanding of a capitalization rate.  If you don't understand how or why the rate is higher for the equity position (Ie/Re) vs the mortgage, you don't understand debt and equity.  This kind of capitalization rate understanding is fine during periods of interest rate stability.  It is very dangerous and short sighted when treasury yields are inverted, have across the board doubled in the past 4 months, and the Fed says they are looking at an additional 200 basis point increase in the short term.\n\nA simple understanding of capitalization rates is fine for multifamily in many markets, but it is not at all fine if you're dealing with any retail, office, or industrial property.\n\nHow would you forecast a terminal capitalization rate for a grocery store anchored shopping center? Just take the rate from your formula and add some random number to it from a survey?\n\nI mean, this is CCIM 101 stuff.\n\n[https://www.ccim.com/cire-magazine/articles/cap-rate-calculations/](https://www.ccim.com/cire-magazine/articles/cap-rate-calculations/)", "replies": [{"id": "i8q6g2y", "text": "The conundrum is people thinking a cap rate is a \"return\".  It is not even though 90% of the internet has been tricked into believing this. \nAnd of course an investor wants to know why they are paying $10 for NOI in one market and $20 in another market but that does not negate the simplicity of V=i/r.", "replies": [{"id": "i8qdssx", "text": "That simplicity is a back of the envelope method for people who understand it. It's no different than small multifamily investors using an GIM.  I don't deny it is useful and use it all the time, but understanding the Ellwood/Ackerson format isn't hard and goes a long way.", "replies": [{"id": "i8qjhpp", "text": "Well the whole point of the thread was about the incorrect definition of cap rate as  \"return\".\n\nNow nothing wrong with knowledge of Akerson but if you have cap rate comps then it is just a waste of time.", "replies": [{"id": "i8r75fq", "text": "Considering interest rates have increased 100 basis points in just the past 3 months, my entire point is by any method you use - whether you're using Argus AE or a simple direct cap table in excel - you absolutely have to make some attempt to forecast mortgage rates at the end of your projected holding period.  As well, if interest rates continue on this trajectory, your cap rate comps are not useless, but you would need to know the equity yield rate and adjust the loan terms in order to determine what the adjusted cap rate would be based on market terms *today.*\n\nUnless you're working exclusively with small multifamily properties, it's not like you have adequate comps from which to extract a rate that have transpired in the past month.\n\nWhat are you going to do if interest rates continue to rise 100 basis points every quarter or even higher over the next year?  If mortgage rates are 8% in 6 months, what does a cap rate based on a 3.5% rate tell you? Nothing, without the analysis I describe.\n\nHonestly, while I own a few retail and warehouse properties, multifamily is still strong in my market. I and my partners mostly focus on cash purchases so we really just look at the gross income.  This is pretty common in the small balance realm.", "replies": [{"id": "i8r7qro", "text": "A 3.5% cap rate tells you that each dollar of NOI traded at $28.57 based on the economic conditions known at that time.  That's all.  Why try to make it more?", "replies": [{"id": "i8r9uc7", "text": "Since that rate exceeds mortgage rates for everything today, those rates, unless adjusted as stated, don't tell you anything and are entirely useless.\n\nIf you adjust them based on current mortgage rates, then they become quite useful.\n\nMany large financial institutions require this in appraisals today, so if you want to get a $50 million loan for a multifamily property from say, Chase, the appraiser will have to do just as I stated. I haven't done many bank appraisals recently, but I'm starting to as the fees justify this kind of work and I know someone at pretty much every bank in my market that would lend on a $50MM multifamily building. Meaning, I can find out the exact loan terms and make the adjustments I described.\n\nYou're obviously green and worked your entire career in a low-interest rate environment and don't really understand finance or economics, so I think you should maybe step back and realize your own ignorance. \n\nAgain, it is quite likely 30-year TIPS bonds will hit double digits like they did circa 1981.  How are you going to make money in commercial real estate if that happens?", "replies": [{"id": "i8rcq7v", "text": "\"Since that rate exceeds mortgage rates for everything today, those rates, unless adjusted as stated, don't tell you anything and are entirely useless.\"\n\nWhat?  You think a 3.5% cap rate exceeds today's mortgage rates?  That is crazy talk.", "replies": [], "depth": 11}, {"id": "i8ridk8", "text": "\"You're obviously green and worked your entire career in a low-interest rate environment and don't really understand finance or economics, so I think you should maybe step back and realize your own ignorance\"\n\nYou are only arguing with yourself. And off on your own tangent.", "replies": [{"id": "i8t4evo", "text": "No, I'm really determining if this platform is worth my time.  And idiots like yourself prove it is not.  I could be training a new employee, or partying with an investment partner. So yeah, the internet of 2022 sucks donkey balls.\n\nEnjoy your poverty!", "replies": [{"id": "i8tyhyg", "text": "Well if you are a working stiff this is not the place for you.  I'm just a rich retired guy trying to undo some of the harm the internet has done over the last 20 years. \nYour attitude does not lend itself to mentorship so yeah there is nothing for you on the internet.  Stick to porn.  Then it can be all about you.", "replies": [{"id": "i8zwati", "text": "And you're still alive?  Yeah, it's easy to make money when interest rates decreased steadily for 40 years.  \n\nBuy, hold, sell.  That's no longer possible, and you're too young to understand how people money prior to the Nixon Shock when interest rates were stable for 25 years.  \n\nI do share your criticism of pornography however.", "replies": [{"id": "i93lzek", "text": "Actually it has only been about 30 years of declining rates other than the 80's blip.  I was there.  \nI also know plenty of people that lost their ass in the declining rate market.\n\nAs to your other comments to my post.  I'm just trying to educate novices that getting sold a 22%!!! cap rate in Memphis doesn't mean you will be seeing a 22% \"return\".\nAs far as the current market we will have to wait to see what sales, if any will trade at under the changed economic conditions.  Cap rates might compress even more .  But, in absence of current cap rate comps then the need to build cap rates via Akerson will be necessary for valuations.", "replies": [{"id": "i94kgpy", "text": "Volker raised rates in 1981, over 40 years ago. But whatever.  I agree that a cap rate is not a measure of return, and that confusion on that subject is very common.  It's little more than an method of determine value or pricing at the beginning and end of a projected holding period. \n\nAs for how to educate overall rates versus yield rates, I've found you either get it or you don't.  Whole treatises have been written on the subject.\n\nAnyway, the game of real estate is very different during periods of stable interest rates versus a 30- or 40-year rollercoaster ride down to almost nothing.  I'm sure we can agree on that much.", "replies": [{"id": "i9drg4j", "text": "Yeah the ride down was nice but you never knew when it would end.", "replies": [], "depth": 17}], "depth": 16}], "depth": 15}], "depth": 14}], "depth": 13}], "depth": 12}], "depth": 11}], "depth": 10}], "depth": 9}], "depth": 8}], "depth": 7}], "depth": 6}], "depth": 5}, {"id": "i8qmtvp", "text": "Your CCIM incorrectly states \"A capitalization rate is the overall or non-financed return on a real estate investment,\".  Cap rates are exactly the same if you pay cash or finance 100%.  They have confused CoC with cap rates.  Not so good for CCIM.", "replies": [{"id": "i8r6fco", "text": "That is not accepted as true by any professional organization (I am a designated MAI member of the Appraisal Institute and hold the CCIM designation).  It also conflicts with FIRREA and pretty much every court of law in which I have testified, including the New York Superior Court.\n\nThe Ellwood and Ackerson methods were essential for anyone developing, investing in, or appraising real estate until DCF software was widely available - i.e. the mid-1980s. \n\nThe equity yield rate (cash on cash is pretty low class on outdated) is part of the Ellwood and Ackerson formulas,  which you apparently didn't bother reading in the link I cited.", "replies": [{"id": "i8r71oo", "text": "Not sure what you think is not true.  Are you saying a cap rate is a return measurement?\n\nI've trained at building  cap rates so not sure what you think I missed by not reading your link.  But in 40 years I only used that briefly after the dot.com crash because there were no sales for cap rate comps.", "replies": [], "depth": 7}], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}, {"id": "i38j55m", "text": "Hey, if we can humor JTR over at r/realestateinvesting, you guys should be able to humor our good friend Bob.", "replies": [{"id": "i38nanu", "text": "Exactly!.............waitaminnit,  is this good cop, bad cop?  LOL\n\nBut seriously. V=i/r\n\n$10=$1/10%\n\n$20=$1/5%\n\nThe variable is the amount (price) the buyer and seller agreed to exchange the NOI.  The cap rate just denotes that value as a percentage.  Where's the \"return\"?", "replies": [{"id": "i38q2q3", "text": "Seriously, if this real estate thing doesn't work out for you, you might be able make it at as a character actor in Hollywood. Your drive, and skill of staying on point to your character in the face of overwhelming disagreement, disproval and disbelief would make you more famous than James Wood.\n\nI am not a math teacher, and so don't know how to teach you algebra any better than:  \n\n\nIf you can get value based on the formula V = i/r\n\nThen you can get the return by: r = i/V.\n\nYou are captivated by the fact that people are willing to pay a dollar amount for current cashflows, but seem unable to view it the opposite way, I'm willing to spend the same dollars so that every year I get x dollars back. And hopefully I'm able to increase the amount of dollars I get back by controlling expenses or increasing prices, and someone else is willing to spend x dollars to purchase my current cashflow.", "replies": [{"id": "i38u4s0", "text": "Oh I see your disconnect.  You think the r is \"return\".  The r stands for cap rate.  It is a rate that you capitalize an income stream (NOI) to estimate value.  It is not a return.\n\n\nNow i know IRV and can calculate all ways.  r=i/V. 10%=$1/$10. All the 10% tells you is that the NOI exchanged for $10.  Where is the \"return\"?", "replies": [{"id": "i38y1gd", "text": "Hrm, okay so it's not a math problem for you but a vocabulary problem?\n\nYou Said:\n\n&gt;you capitalize an income stream (NOI) to estimate value. It is not a return.\n\nCapitalize: reckon (the value of an asset) by setting **future benefits** against the cost of maintenance. So you are correct, I am capitalizing the return into the cost of the property. (emphasis, mine)\n\nRate (verb): assign a standard or value to (something) according to a particular scale.\n\nSo by definition: Capitalization Rate is assigning a value by setting future benefits against the cost of maintenance. \n\nReturn: a profit from an investment.\n\nSo, if I am Assigning a value by the future benefits, I'm literally defining the return.\n\nIt's always fun to try different ways to dissuade you from the same argument that you always make. You don't deviate from your you are purchasing $1 of income for $10, which is silly in the first place because I'm not immediately getting that $1 back, it comes to me in the future (a future benefit) by spending $10 now.   Only Money Laundering works by exchanging $10 today for an immediate benefit of $1.", "replies": [{"id": "i390qw9", "text": "&gt; you are purchasing $1 of income for $10, which is silly in the first place because I'm not immediately getting that $1 back, \n\n???  The NOI came from a calculation.  Then using direct capitalization it's value is determined.  I never said anything about getting that dollar back.  Shoots, you can buy at 10% or 5% and not get ANYTHING back.  I don't see how you jumped to money laundering.", "replies": [{"id": "i3961df", "text": "Correct.  Which is why it's a future benefit that I'm purchasing, and therefore a return. If we are solving for i, then I am spending Value at a rate of C to get i, the return on value of the asset.", "replies": [{"id": "i39inkr", "text": "So some investors are paying $20 in a market but you go to another market where investors will only pay $10 but you have convinced yourself that you will be getting a higher \"return\" yet you can't show that.  The only thing the cap rate shows you is what YOU paid for NOI.  That is not a return.", "replies": [{"id": "i39kxyh", "text": "Your argument is false on the basis: I am paying the seller $10 for each $1 of their NOI.  It's not my $1. That is the Valuation portion of the equation.  \n\nHowever, because I paid that I expect to get that same 10% in the future as a return for spending the $10.  If I expected to get .5c on the $10, I wouldn't be paying the Seller a ratio of $10:$1.\n\nThe seller has come up with their $10:$1 Valuation cap rate.  Perfect. Great. They are totally unreasonable.  The buyer thinks that based on the $10 they are going to get .5c.  \n\nWe've gone round and round on this for years. I find it comical that your argument is always the same with no consideration or exploration of other peoples arguments. You exclude valid points from their comments, focus on the one concept that You can purchase NOI. Which you can't, it's the seller valuing what they've made and determining what it's worth to them to lose that NOI. The buyer determines the return that they are looking for, based on due diligence, experience, and expected capital expenses, to determine what they are willing to pay for that projected return.\n\nYour out of hand rejection of commonly accepted definitions of commonly used formulas, makes you look crazy to the community. And instead of sharing what I'm sure must be some valuable experiences, and valuable lessons, people pre-conceive you to be this crackpot because you are on this crusade to correct everyone to see this formula, as it's only possible use as a valuation method.  Which as we all know, even the appraisal companies don't do.", "replies": [{"id": "i39nho9", "text": "&gt;However, because I paid that I expect to get that same 10% in the future as a return \n\nYet you cannot explain how that \"return\" happens and I have been able to calculate TO THE PENNY the valuation that the cap rate tells you.  Your \"community accepted\" use only make your community look ignorant because NOT ONE of them has been able to show how the cap rate measures \"returns\".  Not even you.", "replies": [{"id": "i39p13l", "text": "&gt;Yet you cannot explain how that \"return\" happens and I have been able to calculate TO THE PENNY the valuation that the cap rate tells you.\n\nAre you saying you don't understand how cash flow is generated in real estate? \n\nAs a Valuation method, yes, you can be as precise as your calculator is. As a predictor of return because we don't know if there is going to be covid 19, or massive universal supply chain slow downs, there is no formula any where that predict what future returns are going to be. \n\nWhat I like about you Bob, is this back and forth reminds me of the Seasonal Looney Tunes Episode where Daffy and Bugs go back and forth,   \n\"It duck season, it's rabbit season\" the problem is, there's no frustrated duck who goes crazy, ending the clip.", "replies": [{"id": "i3j5f9w", "text": "&gt;Are you saying you don't understand how cash flow is generated in real estate?\n\nAre you saying you don't understand the difference between NOI and cash flow?  Of course you won't understand cap rates without that basic knowledge.  \n\nBut then you state,\", **there is no formula any where that predict what future returns are going to be.\"**  So how can you argue that the cap rate formula measures return?", "replies": [], "depth": 13}], "depth": 12}], "depth": 11}, {"id": "i39nqj9", "text": "So if I pay $1,000,000 for $100,000 NOI I will get a 10% \"return\"?  That is what you are saying and that is 100% wrong.  I can show you!", "replies": [{"id": "i39q91l", "text": "So if I pay $1,000,000 ~~for $100,000 NOI~~ I ~~will get~~  expect to get a 10% \"return\" if all other variables remain constant in the next year, which would equal $100,000.", "replies": [{"id": "i39r4h4", "text": "Except I listened to you and thought 10% was a \"return\" which I'd be happy with but Honobob showed me I bought at a 10% cap rate in a 15% cap rate market so there is NO return!!\n\n[https://www.biggerpockets.com/blog/capitalization-rate-definition-myths-debunked](https://www.biggerpockets.com/blog/capitalization-rate-definition-myths-debunked)", "replies": [{"id": "i39s41n", "text": "Did you miss the part where I added: if all other variables remain the same.", "replies": [{"id": "i39wamj", "text": "If you over pay because you don't understand cap rates then \"other variables\" have no impact!  We've gone round and round on this yet you still want to claim a cap rate measures \"returns\" because...it is a percentage?  LOL", "replies": [], "depth": 15}], "depth": 14}], "depth": 13}, {"id": "i8urw91", "text": "There are 3 parts to direct capitalization.  V is value I stands for NOI and r stands for cap rate.  You have been fooled into thinking the r stands for return.  As long as you blindly believe that you will never understand capitalization rate.", "replies": [], "depth": 13}], "depth": 12}], "depth": 11}, {"id": "i39pntj", "text": "&gt;Your out of hand rejection of commonly accepted definitions of commonly used formulas, makes you look crazy to the community\n\nThe only definition I am contesting is from an internet outfit called \"investopedia\"  Hmmm.  But then they also claim it is a valuation metric.  Hmmm.  Who da crazy guy now?", "replies": [], "depth": 11}, {"id": "i39q6ry", "text": "&gt;However, because I paid that I expect to get that same 10% in the future as a return for spending the $10\n\nNOPE. that 10 cap tells you that if you increase NOI by a dollar you will see a $10 increase in VALuE.  But the 5 cap buyer will see a $20 increase.  That is DOUBLE1  Where is your \"return\" now?", "replies": [], "depth": 11}], "depth": 10}], "depth": 9}, {"id": "i3a8cy8", "text": "OP", "replies": [], "depth": 9}], "depth": 8}, {"id": "i3abax6", "text": "LOL", "replies": [], "depth": 8}], "depth": 7}, {"id": "i391bzx", "text": "&gt;So, if I am Assigning a value by the future benefits, I'm literally defining the return.\n\nNo, you are just determining the value.  Either 10% or 5% cap rate or really $10 or $20 where is the \"return\" measurement?  Geez, if I can add a dollar to NOI I increase my value by $20 in the 5 cap market but only $10 in the ten cap market.  Seems my returns at 5% are twice that of a 10 cap!  But it is not a return so that conundrum doesn't happen.", "replies": [{"id": "i393eg2", "text": "&gt;where is the \"return\" measurement?\n\nYes, unsurprisingly you can use the Cap Rate formula to determine the VALUE of your return. V =  i / r. \n\nReturn is a measurement that has a time value, which you seem to not believe in. As pointed out, I don't get an immediate $1 for the $10. I am not actually buying the $1 for $10.  I am paying the $10 for the opportunity to generate $1 if I hold all other variable constant. The seller is saying hey look, here's my return $1, I think you should give me $10 for the opportunity to make $1.  You aren't as smart as me because I paid $5 for the opportunity to make $1. But if you do well, someone else might pay you $20 for the opportunity to make $1.", "replies": [{"id": "i39ku8q", "text": "Where is the return measurement?  All you have shown is the valuation, exactly as I stated.", "replies": [], "depth": 9}], "depth": 8}], "depth": 7}, {"id": "i3eug14", "text": "Don't feed him.", "replies": [{"id": "i3ezgjs", "text": "Too Late for that.", "replies": [], "depth": 8}], "depth": 7}], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}, {"id": "i38j93m", "text": "Why are you threatening me?  This is in response to SFLady's request.  Our texts resulted in nothing because you could not prove me wrong.  Geez, that is all it would take except I'm not wrong.  \n\nSo do you want to ban me for being correct?", "replies": [], "depth": 2}, {"id": "i3926uz", "text": "&gt;I thought we came to a conclusion .\n\nYou have my permission to post my private texts to you.  I looked back and have no idea how you thought there was a conclusion.", "replies": [], "depth": 2}, {"id": "i39c5ra", "text": "&gt;Jesus Fucking Christ !!!!!!!!!!!!  \n&gt;  \n&gt;What the fuck is wrong with you Honobob ???", "replies": [], "depth": 2}, {"id": "i95atss", "text": "NumNumLobster\n\n6y\n\nIt is the ratio of net income to the value of the asset. Say that 5 times. It is not a return. It is a pricing metric to scale similar assets valuations.\n\nAs several others have mentioned in this thread a cap rate is not a return.  Why be upset with me?", "replies": [], "depth": 2}], "depth": 1}, {"id": "i393pri", "text": "I am not sure what you are all arguing about.   \n\n\nA cap rate is simply a way to gauge the value of an asset based on the current demand using the last 12 months of NOI. Cap rate determines value, not return because it requires the NOI for the formula.  \n\n\nThe cap rate adjusts for age, condition, market forces/demand, etc. It's not a one size fits all which tends to confuse a lot of people, especially those who invest in 1-4 units. This is a commercial sub, so most should have a basic understanding of this.", "replies": [{"id": "i3998bv", "text": "Exactly, a valuation metric.  V=i/r.  But here we are on a commercial real estate forum and look at the angst.", "replies": [], "depth": 2}, {"id": "i7hpnga", "text": "&gt;I am not sure what you are all arguing about.  \n&gt;  \n&gt;A cap rate is simply a way to gauge the value of an asset based on the current demand using the last 12 months of NOI. Cap rate determines value, not return because it requires the NOI for the formula.\n\nFrom an income approach to VALUE!", "replies": [], "depth": 2}], "depth": 1}, {"id": "i3f0qal", "text": "This guy is the missing link between the amoeba and the first fish with legs.", "replies": [], "depth": 1}]