Cap rates and interest rates
November 3rd, 2005 by KenricJust wanted to post a little about cap rates and interest rates. In commercial a few years ago, we were seeing that cap rates were above interest rates. The cost of borrowing money was cheaper than the return of the property.
During this time, you had almost unlimited upside in your ROI when looking for property.
Imagine a property with a 6% cap rate. For sake of keeping it simple, let’s assume the loans are all interest only. Paying cash on this property yields a 6% ROI no matter what the going interest rates are.
If interest rates are lower than 6%, you could theoretically borrow 100% and make unlimited ROI. As you can see from the graph, as you put more down, your ROI decreases until it gets to 6%. 6% is the lowest ROI you can get on this investment.
If interest rates are higher than 6%, the opposite is true. The HIGHEST ROI you can get is 6%. In fact, you need at least 15% down just to break even.
If interest rates are equal to the cap rate. Your return is 6% no matter what you put down.
Posted in Real Estate | 
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