Cap rate—capitalization rate—is the first metric most investors learn. It's simple: NOI divided by purchase price. But this simplicity masks nuance that separates experienced investors from beginners.
What Cap Rate Actually Tells You
Cap rate is a snapshot of unlevered yield. It answers one question: if you paid all cash for this property, what annual return would you get from operations alone?
That's useful, but limited. Here's what cap rate doesn't tell you:
- **Nothing about appreciation.** A 4% cap in San Francisco might outperform an 8% cap in a declining market.
- **Nothing about leverage.** Your actual returns depend heavily on financing terms.
- **Nothing about quality.** Low cap rates often signal lower risk, not just higher prices.
Market Context Matters
A 6% cap rate means different things in different contexts:
- **In a 5% cap market:** You're paying below market. Dig into why.
- **In a 7% cap market:** You're paying a premium. The property should justify it.
- **Compared to Treasuries:** Real estate should offer a spread over risk-free rates.
The "right" cap rate depends entirely on the market, asset class, and your investment thesis.
Beyond Entry Cap: Exit Cap and Going-In IRR
Sophisticated underwriting considers three metrics together:
- **Entry Cap:** What you're buying at today.
- **Exit Cap:** What you expect to sell at. Usually higher (compression) or lower (expansion).
- **Going-In IRR:** Your total expected return including appreciation, rent growth, and leverage.
A property with a high entry cap but expected cap rate expansion might underperform a low-cap property with stable or compressing cap rates.
The ScoutzOS Approach
Our underwriting engine calculates cap rate alongside cash-on-cash, IRR, and DSCR—giving you the full picture in seconds. We also factor in market cap rate benchmarks so you can see how your deal compares to the broader market.
Stop relying on a single number. Underwrite like a professional.