Discover the difference between deal and market cap rates and how mastering both helps you spot below-market deals, gain instant equity, and increase cash flow.
What You’ll Learn:
- What cap rates really mean
- The two cap rates every deal has (and why they matter)
- How to calculate deal cap rate vs. market cap rate
- Real-world examples to help you avoid costly mistakes
- The ultimate strategy to buy smarter and earn more
Unlocking Smarter Real Estate Deals
Cap rates are one of the most talked-about metrics in multifamily and commercial real estate and also one of the most misunderstood. For beginners especially, it may feel like you need a finance degree just to grasp their significance. Even if you think you’ve wrapped your head around what a cap rate is, I’m here to share something that might surprise you: every deal has two cap rates.
Understanding the difference between these two can change the way you evaluate deals entirely. Not only can it unlock more profitable deals, but it can also protect you from making costly mistakes. In this training, we cut through the confusion and explain cap rates in a clear, strategic way and reveal what you really need to know before making a deal.
Cap Rates 101: Building a Foundation
Before we dive into the two types of cap rates, it’s essential to understand what a cap rate actually represents. With this foundation in place, you’ll be better prepared to make the distinctions that matter.
What Is a Cap Rate?
At its core, a cap rate is the return on investment (ROI) you’d receive if you paid all cash for a property. No financing, no mortgage—just a straight cash purchase.
In other words, a cap rate is:
- An unleveraged ROI: There’s no debt or financing involved.
- The percentage of property value expected to earn annually, excluding mortgage costs.
The common thread? No mortgage enters the calculation. If you’re factoring in financing, you’re stepping into a different metric entirely—cash-on-cash return—which serves a different purpose.
Why Cap Rates Matter to Investors
Knowing what a cap rate is matters because it’s more than just a metric—it’s a powerful tool for investors. Here are three key reasons why you should master cap rates:
- Quick Comparison of Profitability
It allows you to quickly compare the profitability of commercial properties. For example, if you’re considering two properties side by side, understanding their cap rates can help you determine if you’re overpaying for one versus the other. - Assess Potential ROI
Cap rates help investors evaluate the potential return on an investment property based solely on cash flow, independent of mortgage financing. - Smarter Decisions
Most importantly, understanding both types of cap rates is essential before investing in any multifamily or commercial property. Knowledge of both is your key to making informed, confident decisions.
The Two Cap Rates You Need to Know
Every real estate deal—whether multifamily or commercial—has two cap rates and each plays a critical role:
- Deal Cap Rate
- Market Cap Rate
Once you understand this concept, it will fundamentally change how you evaluate every multifamily and commercial real estate deal.
Deal Cap Rate: Specific to the Property
The deal cap rate is the one you’re probably most familiar with. It’s calculated based on the specific property you’re analyzing.
Formula:
Deal Cap Rate = Net Operating Income ÷ Sales Price
- Net Operating Income (NOI): This is the property’s annual income after deducting operating expenses.
- Sales Price: The price you’re paying to acquire the property.
Example: You’re looking at a 10-unit apartment building. The annual net operating income is $50,000, and the purchase price is $1,000,000.
- Deal Cap Rate = $50,000 ÷ $1,000,000 = 5%
This is typically the number you’ll see on listing brochures and investment summaries—but here’s the caution: it doesn’t tell the whole story. Relying solely on the deal cap rate when deciding to buy is a mistake. It’s essential to compare it to something larger—the market standard.
Market Cap Rate: Context is King
The market cap rate serves as a benchmark. It is the average deal cap rate of recently sold, comparable properties in the same area.
Example: Consider three properties recently sold in a specific neighborhood.
- Property A: 4.8%
- Property B: 5.0%
- Property C: 5.2%
The average of these is: (4.8% + 5.0% + 5.2%) ÷ 3 = 5.0%
This becomes your market cap rate. Now you have a critical point of comparison to assess whether a property is priced appropriately.
Game-Changing Strategy: Leverage the Comparison
So what’s the big takeaway? Always compare the deal cap rate to the market cap rate. Here’s why:
- If the deal cap rate is higher than the market cap rate, the property might be undervalued—a potential opportunity to buy below market value.
- If it’s lower, you could be overpaying and that could hurt your returns.
Applying the Strategy: Real-World Impact
The ultimate goal in multifamily and commercial investing is straightforward: You want to find a deal where the deal cap rate is greater than the market cap rate. Step one is to understand the market cap rate—you’ve already learned how to calculate it by averaging the cap rates of recently sold comparable properties. Once you know the market cap rate, your next step is to find a deal where your deal cap rate exceeds the market cap rate.
Real-World Example
Let’s return to our earlier example to see this strategy in action.
- 10-unit property
- NOI: $50,000
- Market Cap Rate: 5.0%
- Original Price: $1,000,000 → Deal Cap Rate = 5.0%
Now let’s adjust the offer to unlock a better deal and increase the deal cap rate:
- New Offer: $900,000
- New Deal Cap Rate = $50,000 ÷ $900,000 = 5.55%
What just happened?
- You bought below market value
- You gained instant equity of $100,000
- You borrowed less, reducing mortgage payments
- You’ll see a boost in both cash flow and cash-on-cash return
Simply by adjusting your offer based on cap rate comparison, you’ve created a more lucrative deal.
The Competitive Edge: Your New Deal Goggles
This approach gives you a strategic advantage. Most agents and sellers won’t volunteer the information about market vs. deal cap rates, so it’s on you to bring this insight to the table. Think of it like putting on a new pair of deal goggles. From now on, with every multifamily or commercial property you analyze:
- Calculate the deal cap rate
- Determine the market cap rate
- Compare the two
- Make an offer that ensures your deal cap rate is greater than the market cap rate
This method sets you apart from casual investors—and puts you in the driver’s seat of smarter negotiations and better long-term value.
Key Takeaway: The Real Truth About Cap Rates
To recap: every property comes with two cap rates—the deal cap rate and the market cap rate. Understanding how to compare them, and strategically leverage that comparison, gives you powerful insight into every property’s true value. The better you grasp these cap rate dynamics, the better deals you’ll uncover and the more equity, ROI, and cash flow you’ll secure.
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