In Commercial Real Estate investing….what does “90% cap rate” or “5cap rate” refer to?

Question by scottw2100: In Commercial Real Estate investing….what does “90% cap rate” or “5cap rate” refer to?
I’ve heard brokers and investors talk about this as an indication of a projects health, vialbility as an investment, etc…but I don’t understand the foundation of the concept.

Best answer:

Answer by Summit Seeker
Cap rate is the ratio of the net operating income divided by the price (times 100 to make it a percentage). You can think of it as analagous to the return you would get by buying a CD from a bank. For example, a 0,000 CD yielding ,000 represents a return of 5,000 / 100,000 = 5%. The cap rate is the same idea, but for real estate. If the property generates ,000 in net income and costs 0,000 to purchase the cap rate would be 20,000/400,000 = 5%, same as the bank CD. Since CDs are risk-free (insured by the gov’t), you would purchase the CD in this case and pass on the building since both yield the same return, but the CD has no risk.

I’ve never heard of a 90% cap rate, 8-12% is typical, compared to 4-6% typical for CDs. The extra return is due to the extra risk of owning property. So, the cap rate is a quick way of telling whether the seller’s asking price is a good or bad deal. 10% is typical.

What do you think? Answer below!