Since people are interested I'll elaborate on CAP rates and a note on depreciation, appreciation, and the overall tax advantages of owning real assets like this (mostly real estate).
The cap rate is used in valuing real estate and is calculated using EBITDA. Earnings before interest, income taxes, depreciation and loan amortization.
The lower the cap rate the higher the price you pay relative to EBITDA. A 10 cap means you are paying a price 10x EBITDA or you are accepting a 10% return on an annual basis on your investment. A 6 cap means you are accepting a 6% return on your initial investment in the form of EBITDA.
Really safe and secure assets generally have low cap rates. Self storage has one of the lowest cap rates of them all because they have a ton of tenants all paying a low amount. It would take an act of god to lose 50% of your tenants in any given month so its safer. Cap rates in major metros are sometimes south of 5%. The industry average is around 7%. Meaning investors in big cities are willing to pay a price that would produce a 5% annual ROI.
A fast food restaurant chain with years of history and 20 locations would have a low cap rate because its safer than a single mom and pop restaurant. Assets with management companies in place (making the income passive) have lower cap rates and more value than an
Basically the more stable, low risk and passive the income is the lower the cap rate.
A single family property on the other hand has 1 tenant. If that tenant moves out you get 0 income. Thats risky and in most markets is reflected by a higher cap rate closer to 10 or even 20. A website that is one google alg change away from being crippled would be a 50 or even 100 cap. Thats why they don't use cap rates for assets like that.
Cap rates are different than your actual returns. You'll need to run your own pro formas based on your interest expenses and your financing terms. You'll also need cash on hand for principle payments as well that aren't technically expenses as far as tax liabilities go.
When buying real estate you also have to think about the advantages of the depreciation, appreciation and lower tax liability upon exit.
Depreciation means you can write off your full purchase price (even though the bank owns 75% of it) over time against your profit. If you pay $1MM for an asset and its depreciated on a 27.5 year schedule (standard for commercial assets) you get to write off about 4% of that purchase price, or 40k a year, in losses even though you didn't incur them. That significantly reduces your tax liability on a yearly basis.
Then theres the fact that in most markets you get to realize about 4% annual appreciation on your asset (averaged over time) based on the full purchase price even though the bank owns 75% of it. Basically your cash down if it was 25% will grow 16% a year just in equity and value just because you realize appreciation on the bank's portion too.
Its an amazing system if you can buy at the right price, cashflow, depreciate and realize appreciation later either when you refinance or sell the asset.
Add to all of this the capital gains tax when you finally do sell your asset. If you own it for more than 1 year before selling it instead of paying 35% like you do on your income you pay 15% on the gains you realized. Its insane!
You also have the option to do a 1031 like kind exchange where you buy a similar asset with the profit from the previous sale and avoid taxes all together (pushing the liability further into the future).
This entire system is why real estate should be the end goal of all of us and why the American wealthy just keep getting richer and richer and richer.
Now for some opinion that shouldn't be regarded as fact but i'm interested in some opinions:
A lot if big city markets are the target of parking money (basically protecting cash by just buying something and being okay with no return) and speculation. That messes up cap rates and is the reason why some single family homes in Boston are trading at a 4 cap. Insane right?
People are buying them not for the cashflow but either to protect their cash or realize appreciation when someone pays even more for it later and you can flip it and make a profit. Some of our major cities have a lot of foreign money coming in and buying up homes because the foreigners want to protect the cash from their own government due to political instability or in many cases tax evasion and money laundering. Some corrupt government organizations like the Saudi's are beginning to seriously invest in American real estate and its throwing things out of wack.
Sounds a little like a bubble right?