Cap rates with lower risk mean lower risks, and higher rates are associated with higher risk. So it is up to you to decide which type of investment to make.
I find that many investors are confused by the distinction between cap rate or cash-on/cash return. Let me clarify... they don't have to be the same. The cap rate can match your cash/on-cash return, but that is only if the property is purchased without financing.
The caprate can be useful in quickly comparing comparable real estate investments in the marketplace, but it should not serve as an indicator of an investment’s strength. Because it does not consider leverage, the time value money, future cash flows, and property improvements, it is not a reliable indicator of an investment’s strength.
One rule of thumb in regards to cap rate: Good neighborhoods tend to have lower cap rates, while poorer areas are more likely to trade at higher caps. It's generally safe to assume that the 15% cap rate property you find is not in a great place.
The mortgage expense is not included in the cap rate. This is because it doesn't factor in financing terms, interest rates or any other considerations. This is how it concentrates on the property without all the distractions that come with financing.
Other buildings also influence the cap rate. Consider two buildings in the same location. The updated one may have a cap of 5 percent, while the one in desperate need of renovations might have a cap at 7%.
Knowing the importance of cap rates and how they work is essential to become a successful realty investor. The concept of a "cap rate" may seem abstract, but it can be very useful. Understanding the concept of a cap rate can help you choose a particular market, property type, set investing criteria, analyze, then decide whether to buy or sell a home.
