what is considered a good cap rate
Cap rates are a proxy for deciding which investment is better or less risky. A lower caprate will generally indicate a safer or more-risky investment. Conversely, a higher caprate will mean greater risk.
Many advisors will tell an investor that a higher caprate is better. The truth is that the higher cap rates are more likely to yield higher returns. But cap rates can't be everything. A property purchase decision should consider factors such as investor risk appetite and property location. Opportunities with low cap rate investment might be worth looking into for certain risk-averse investors.
The debt factor is also not taken into account in cap rates. Other return metrics like cash-on-cash returns (CASH) and internal rate or return (IRR), should also been calculated. They paint a larger picture of the opportunities.
Cap rates are a proxy for deciding which investment is better or less risky. A lower caprate will generally indicate a safer or more-risky investment. Conversely, a higher caprate will mean greater risk.
Simple formula to calculate a cap rate: Cap rate is the annual NOI divided the market price of the property. A property worth $10 million that generates $500,000 of NOI, would have a cap-rate of 5%.
Also, cap rates change frequently. They change according to changes in the property's value or NOI. This change can also be caused by market conditions and investor improvements.
The same cap-rate formula can be used for estimating the value of a property based upon its NOI. As shown in the above example, if you know that the property is producing $500,000 in NOI and the appropriate rate (i.e.., unlevered yield) for a similar project is 5% you can divide $500,000 times 5% to get a $10,000,000 value. An $8.3 million project might only be worth 6% if there is an appropriate market rate. This is a good example of how shifting return expectations (in this case the caprate) can cause implied property values to fluctuate.
Cap rates are often compared with the coupon on bonds because both can be used as a way to express payment as percentage of asset value.
