The difference between caprate and cash-on–cash returns is something I see many new investors get confused about. Let me clarify... they do not match each other. You can get a cap rate to match your cash on cash return if you own a property, but they are very different calculations.
Mortgage expenses are not included in the cap rate. This is advantageous because it allows for more precise analysis without factoring in financing (terms and interest rates, etc.). This means that it is focused on the property only and doesn't factor in financing.
What is the general rule of thumb regarding cap rates? Cap rates for better neighborhoods are lower and those in less desirable areas tend to be higher. If you see a property with a 15% cap rate, it is likely not in a great location.
The cap rate for a property is the same regardless of financial status. This helps you benchmark profit potential consistently and accurately, while also allowing you to keep your investment portfolio in check. Cap rate is essential if you want to build wealth.
Higher cap rates can mean lower risk. Lower caps are more risky.
Also, the surrounding buildings have an impact on cap rates. Two buildings located in the same neighborhood might have different cap rates. One that was updated recently may be valued at a 5 percent cap while the other one is worth renovating at a 7 percent cap.
It is crucial to be a successful investor in real estate by understanding the cap rate and its functions. The idea of a caprate can seem quite mathematical but it also has many practical uses. This concept can be used to help you select a market or property type, determine your investment criteria, analyze and decide whether or not to sell a property.