Real Estate Cap Rates Explained

Real Estate Cap Rates Explained // The cap rate is one of the most widely referenced investment metrics in all of commercial real estate, but despite how popular the cap rate term is, this still tends to be one of the most misunderstood metrics in the entire real estate industry.

A quick Google search will tell you that the cap rate is just a property’s net operating income (NOI) divided by the property’s purchase price.

But even though this is an extremely basic calculation, there is so much more to this metric than just a simple division problem.

There are a ton of different factors that end up affecting cap rates in a market, and while a higher cap rate does mean a higher yield for investors going into a deal, that doesn't necessarily mean that a deal is more profitable than a lower cap rate transaction, or even profitable at all.

So to address some of the most commonly asked questions inside the Break Into CRE coursework and from Break Into CRE Academy members, in this video, let’s take a step back and talk through what cap rates actually are, what drives cap rates up or down on commercial real estate deals, and some rules of thumb that you can use to know where a property might fall on the cap rate spectrum.

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🕒Timestamps🕒:
0:00 Introduction
1:18 What Is a Cap Rate?
2:32 Driver #1 - Income Upside
5:12 Driver #2 - The Risk-Free Rate
7:22 Driver #3 - Risk of Capital Loss
9:55 How To Level Up Your Real Estate Investment Analysis Skills

*Nothing in this video should be construed as tax, legal, accounting, valuation, or financial advice or recommendation. All information in this video is intended solely for educational purposes, and you are advised to consult with your own personal professional advisors regarding your personal investment decisions.

**AFFILIATE DISCLOSURE: Some of the links in this description are affiliate links, meaning, at no additional cost to you, we may earn a commission if you click through and make a purchase and/or create an account.

[BreakIntoCRE]

Any other real estate finance metrics you'd like to see covered in more detail on the channel?

[clintymouse]

Taking a real estate course and this REALLY helped clarify a topic that is poorly explained in the course. Than you!

[colonysurf]

Cap rates don't represent YIELD. All a higher cap rate tells you is that investors will not pay more for a dollar of NOI than in a lower cap rate market.

[christopherroque]

I would love to see a video on how to identity primary comps!

[JCurve]

This channel has become my new go-to for learning about basic & intermediate CRE concepts. I recently invested in your classes and I am already applying the skills learned in my job. I am very grateful for your content - keep up the great work!

[mirteshappy]

Cap rates are a snapshot at the moment that the property is being acquired. After that...

[nagahamaekenta]

Could you kindly give your opinion why the office yield is higher than that of residential in US. The office properties seem to be more stable due to NNN mid long term lease and more simple to manage/operate, which leads to lower yield.

[bobbowling]

This is incorrect. Cap rates come from an income approach to value called direct capitalization. It is NOT a "return" metric. In a 10% cap rate market NOI has sold for $10 per possible dollar, In a 5% cap rate market they have paid $20! If a 10% was a "return" then why is twice the "return" of the 5% cap rate market selling for HALF the price? It doesn't because cap rates measure value, not return.

[themortgagechic_ca]

Thanks so much Justin. Have learnt an awful lot from you!!!

[liammoore]

Great vid, Justin! What about a topic on JV vs Syndicated investor structures and the pros and cons of each?

[thatgirlyami]

Thank you so much! I was able to pretend I knew what I was doing in front of my boss 😂

[Seattleskate]

Multifamily cap rates in SD are incredibly low right now. I'm seeing 2-3% caps everywhere from PB all the way to El Cajon. Crazy times in the market.

[kevinmosher]

Great insight as always! Would love to get a video breakdown of multifamily brokerage commissions, in particular how much a broker actually brings in from 65 bps fee on a large deal after splitting with company and team members. Really just further detail into the pay structure of associate brokers vs VPs vs managing directors.

[leivibartfield]

Thanks Justin! LOVE YOUR VIDEOS.

How do I determine what the cap rate should actually be vs what the NOI is telling me the cap rate is.

What are general KPIs? For example if I get a deal and they're underwriting at 28% expense ratio. (zero management vacancy's at 3% and maintenance at 3%) I know I need to make adjustments closer to 40-50% and work from there.

For example picking up a class C deal with median income of 40K at a 5 CAP = stinky deal vs picking up a class B (B+) median income of 120K 5 CAP = I'd buy that every day of the week.


Thanks for all your content it's AWESOME!

[marcelblack]

Get video! Where can I find the calculator that you use?

[mcmmcm]

Hey Justin,

where can i download your excel in This Video ? Awsome!! 👌🏻

[timothybracken]

hi is the REFAI good for someone who's interested in REPE in the future? thanks

[michelasayag]

Hi
Can you share the pro forms page to calculate the deal
Thanks

[Bismarkdee-bn]

Its worse here, our economy is like a flailing fish, fighting for its life. The normal state of the U.S. economy is actually very bad. Because of this it goes into convulsive spasms fighting to grow any way it can out of desperation. Tricks, gimmicks, rule changes try to stimulate the economy and prevent it from falling but they only bring temporary relief to people since, when you factor in inflation we are declining.

[andrewhaohuang]

Thanks so much Justin for explaining it so clearly!!!