[quote user=ryanlake]Can someone shed some light on this and what is essential to know about them?
CAP rate is CAPitalization of the income stream into perpetuity.
As an example, if someone gives you $10,000/month, for life, what are you willing to pay for this ?
It is the equivalent of the P/E ratio in the stock market. A high growth
stock might command a 30-50 multiple (or 2-3% CAP rate equivalent),
where as poor stock might be 8-10 (or a 10% to 12.5% CAP rate
equivalent).
It is a reflection of the reliability of this income stream, i.e. risk. Is it growing ? Is it very variable i.e. up and down due to rent roll fluctuations or vacancies ? How long are vacancies if there is one (much long in industrial or office buildings than apartment buildings, for example) ?Is the city growing with upside or is there negative pressure on rent ? is the building old and ugly and needs lots of work ? Is there a lot of competition from new construction ? How easy is it to replicate this very unique or very average asset ?
Generally, a bigger city with more diversity, high land prices and growth prospects command the lowest CAP rates, whereas a smaller town with only one industry will command a higher CAP rate.
As a rule of thumb in Canada:
around 4% for Vancouver,
5% for Calgary,
5.5% to 5.75% for Edmonton, GTA or Burnaby, Surrey, Winnipeg, Regina, Saskatoon or Halifax
6% for Hamilton or Sudbury or Red Deer or Kingston
7%+ for very small towns
Usually about 2% higher than the mortgage rate, but not always. If it is higher than the interest rate for a mortgage (around 3% these days) it is referred to being "positively geared".
Risk, interest rate, property type, vacancies, quality of area, quality of asset all influence this rate.
Another metric we look for is price per unit and price per square foot of rentable space.