What is a Good Cap Rate?

Posted on April 13, 2022 by Jordan Dessauer

I get this question all of the time. I always have to revert back to Albert Einstein. I know what your thinking? Albert Einstein and real estate investing? What is this guy talking about? Well stay with me…

Cap Rate is a relative term based on where you are and what you are investing in. In other words, it changes depending on where you are and what type of asset class you are looking at (apartments, storage units, office buildings, retail, etc.). There is really no specific cap rate that is good or bad. Instead the question, what is a good cap rate, you need to ask is: What is a good cap rate on the South side of Chicago for Apartments.

Cap rate, which by the way, stands for capitalization rate is the barometer that gives the investor the understanding of value of a certain asset class, in a certain area. It is really no different than how we as Americans shop for other items in stores. When we look at the price tag of an item at the store, we immediately make the decision of whether or not it is of value based on where we are shopping. Cap rate allows us to do the same thing with real estate.

Typically, cap rate is only used for commercial properties. Non-commercial properties (residential) usually use another form of valuation called the sales comparison method. When you use cap rate you are basically concerned with two things. One, what is the Net Operating Income of the property? Two, what is the sales price? Cap rate shows the relationship between both of those two items.

If you take the sales price and divide it into the net operating income, you will get what the cap rate is. Now, that is the cap rate of the deal (price tag), you still have to figure out what the cap rate of the area is (where you are shopping). A market cap rate is an important step you want to make sure you understand. The three ways you can easily find a market cap rate are:

1.    Do research online.

2.    Talk to a good commercial real estate agent or Broker.

3.    Talk to a commercial Appraiser.

So a little higher cap rate on a property than the market that it is in, means that you are probably on the right side of a deal. A deal that has a cap rate lower than that of the area that it’s in, could indicate that you could be paying too much. Make sure you have adequate figures and the information of how the asset got priced.

One last thing, you don’t want to always go after extremely high cap rate compared to an area. It is usually is an indication of unstable income. Something is causing the unstable income and for the novice investor it could be disastrous! Make sure you do proper due diligence before buying that type of property.

If you remember some of the things that we discussed here with regard to cap rate, you can do quite well. It could make the difference with what level of success you obtain. Heck, even Albert Einstein could have been a good real estate investor with this information if he wasn’t trying to figure out how the universe worked!

“Remember…wealth has nothing to do with money, success has everything to do with failure, and life is as simple as you want to make it!”

– John Dessauer