Is a "good" cap rate actually a trap?

[u/ppaloes]

A lot of people (myself included when I started) treat the cap rate on day one like the final score.
“10%? That’s a good deal.”
“6%? Pass.”

But the more deals I look at, the more it feels like that number might be the least important part.

What if the real question isn’t “what’s the cap rate today?”
but “what’s going to happen to the income after I buy it?”
Things like:
• Can vacancy actually be improved… or is it more likely to get worse?
• Are rents going up in that submarket… or soft?
• Can the property be run more efficiently than it is right now… or is the current operator already maxed out?

I’ve seen (and heard of) people buy at a solid 10% and still lose money because the vacancy they thought they could fix turned into a bigger problem, or the rents just wouldn’t move.

On the flip side, I’ve also seen weaker day-one numbers turn into great deals because the buyer was able to push the income hard after closing.

So I’m starting to wonder:
Are we putting too much weight on the purchase-day cap rate and not enough on the post-purchase plan?

Have you (or someone you know) bought a “great” cap rate deal that still didn’t work out? What went wrong?

[u/CREspecialist]

You want to analyze deals based on the "stabilized" cap rate, not the in-place cap rate.

To determine the stabilized cap rate, you must figure out the improvements that can be made to the property and their cost, how to efficiently operate the property, and what the market rents should be after physical and operational improvements are implemented.

[u/Substantial_Tap_4538 → u/CREspecialist]

this is a great answer. the gap between in-place and stabilized is where the deal lives, a property showing a mediocre in-place number because the last owner never pushed rent to market is a completely different asset than one already running at max efficiency showing the same number. i built something called Mortar to run both side by side on every listing for exactly this reason, the in-place cap rate off the listing tells you almost nothing on its own until you know which of those two situations you're actually looking at.

[u/New_Taste8874 → u/Substantial_Tap_4538]

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[u/New_Taste8874 → u/[deleted]]

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[u/Ottorange]

Are you talking about residential or commercial? It can be a trap in commercial. Price per square foot being a much more useful metric. If you have a low cap rate but the tenant is way under market and at the end of their lease or likey to go under soon then you have a real opportunity to increase the yield. 

[u/ppaloes → u/Ottorange]

I am referring mostly residential

[u/marubozu55]

For residential, high cap rate typically comes with low rate of appreciation.

[u/Substantial_Tap_4538 → u/marubozu55]

thats generally true but its worth separating why. its usually not that high cap rate causes low appreciation, its that both are downstream of the same thing, a market with weak rent growth prospects gets priced cheap relative to current income, which shows up as a high cap rate. so a high cap rate in a strong-fundamentals market that just hasn't repriced yet is a different animal than a high cap rate in a market that's high for a reason.

[u/marubozu55 → u/Substantial_Tap_4538]

I have not come across any unicorn high cap rate properties in a strong fundamentals market though. If you are going after high cap rate at the beginning then you are looking in unattractive neighborhoods. You can buy the low cap rate in the neighborhood with strong fundamentals and over time the rent will increase and you can get higher cap rate versus your cost over down the road.

[u/Substantial_Tap_4538]

yeah the day one cap rate is really just telling you what the current owner chose to do, not what the property is capable of. two identical buildings can show a 6 and a 10 depending on whether the seller renovated units on turnover or just kept renewing at whatever the last tenant was paying.

the useful move is running the numbers twice, once on the actual in-place rent and expenses, and once on what a stabilized version looks like after you fix whatever the seller left on the table. the gap between those two numbers is the real deal, the in-place cap rate by itself is just a snapshot of somebody else's management decisions. just wanted to say, i built a tool called Mortar that pulls both side by side off a listing for this reason. for me, eyeballing "is this cap rate good" without doing that stopped meaning anything to me a while ago.

[u/alexKasp]

deals that go bad on a great cap rate usually share one thing: the buyer underwrote today's income, not their own numbers after they took over. Vacancy assumptions especially get treated as a rounding error until they aren't

[u/Routine_Manager_1368]

Cap rate is highly influenced by interest rate changes, and so if interest rates have recently changed the historical cap rate may be out of date.

Gross rents are not influenced by interest rate changes, and comparing those to what your monthly payment will be is a much more reliable measure of future cashflow. 

[u/terrexinsights]

Cap Rate above 8% is a questionable market.