Cap Rates Are a Lie (And Everyone Knows It)

The Big Fat Cap Rate Con

Remember when your broker showed you that "7.5% cap rate" property and made it sound like free money? Yeah, about that...

Cap rates are to real estate what BMI is to health: A crude, outdated metric that ignores 90% of what actually matters. But hey, it gives everyone something to talk about at networking events while pretending they know what they're doing.

What They Tell You

Cap Rate = NOI / Purchase Price = Magic Number That Determines Everything

Translation: "Just divide two numbers and you'll know if it's a good deal!"

Except... no. Not even close.

What They Don't Tell You

Cap rates don't include:

🚩 The massive deferred maintenance hiding in the inspection report
🚩 The fact that your "market rent" is 20% above what anyone will actually pay
🚩 The below-market debt you're assuming that expires in 18 months
🚩 The reality that 3 of your 5 tenants are barely solvent
🚩 CapEx needs that would make a construction company blush

But sure, let's reduce a $5 million decision to a single percentage. What could go wrong?

The "Market Cap Rate" Fiction

Broker: "This is trading at a 6.5% cap, which is below market!"

You: "What's the market cap rate?"

Broker: "6.8%!"

You: "Based on what data?"

Broker: "Uh... comparable sales and... industry trends and... look, do you want the property or not?"

Here's the dirty secret: "Market cap rates" are whatever number makes the broker's listing look attractive. It's circular reasoning wrapped in a spreadsheet and sold as "analysis."

The Cap Rate Shell Game

Seller's cap rate: Based on "pro forma" NOI (aka fantasy numbers)

Assumes 95% occupancy (currently at 72%)
Uses "market rents" (20% above actual)
Excludes "non-recurring" expenses (that recur annually)
Result: 7.2% cap! 🎉

Reality cap rate: Based on actual trailing 12-month numbers

Actual occupancy: 72%
Actual rents: $200/unit below pro forma
Actual expenses: 15% higher than budgeted
Result: 5.1% cap. Whoops. 😬

Why Cap Rates Are Broken

1. They Ignore Time Value of Money

A 7% cap rate property with:

10-year leases = Solid
2-year leases = You're screwed

Both show the same cap rate. See the problem?

2. They Don't Account for Growth (or Decline)

Property A: 7% cap, NOI declining 5% annually (dying market)
Property B: 5% cap, NOI growing 8% annually (emerging market)

"Experts" say: Buy Property A! Higher cap rate!

Reality: Property A will be worth 30% less in 5 years.

3. They Ignore Capital Expenditures

"8% cap rate! What a deal!"

Year 1: New roof needed ($500K)
Year 2: HVAC replacement ($300K)
Year 3: Parking lot re-paving ($200K)

Actual return: Negative. Congratulations, you played yourself.

The "Flight to Quality" Bullshit

Industry wisdom: "Lower cap rates = better quality properties"

Reality: Lower cap rates = bigger fools with more money

That 3.5% cap rate Amazon warehouse in Des Moines? It's not "high quality"—it's aggressively overpriced because institutions have too much capital and nowhere else to put it.

Meanwhile, that 10% cap rate strip mall? Yeah, it's high for a reason. Probably several reasons. Probably very bad reasons.

Cap Rate Compression = Bubble Territory

When cap rates compress (go down), prices go up faster than income.

Translation: You're paying more for the same cash flow.

Translation of translation: You're the bagholder at the end of a cycle.

But don't worry—the broker assured you "the market fundamentals are strong!" (They always do. Right before everything collapses.)

What They Should Tell You (But Won't)

Cap Rates Only Work If...

✅ The NOI is legitimate (it's usually not)
✅ You're comparing truly comparable properties (you're not)
✅ The market is efficient and rational (lol)
✅ You ignore financing (the biggest driver of actual returns)
✅ You assume nothing ever changes (it always does)

So basically, cap rates work great in a fantasy world where numbers don't lie and markets are rational.

Spoiler alert: We don't live in that world.

What You Should Actually Care About

Forget cap rates. Here's what matters:

1. Cash-on-Cash Return (After Debt)

"How much cash do I get on the cash I invested?"

This actually tells you something useful. Cap rates don't include financing. You know what includes financing? Every actual real estate investment ever made.

2. IRR (Internal Rate of Return)

Accounts for:

Time value of money ✅
Exit timing ✅
Cash flow changes ✅
Your actual equity investment ✅

Much harder to bullshit.

3. Equity Multiple

"How many dollars do I get back for every dollar invested?"

Simple. Clear. Hard to manipulate.

4. Tenant Credit Quality

A 6% cap with Amazon is worth infinitely more than an 8% cap with "Joe's Vape Shop & Tattoo Parlor LLC."

But both are "just cap rates!"

The Bottom Line (That No One Will Tell You)

Cap rates exist to:

Give brokers something to put in listing presentations
Help appraisers pretend real estate values are scientific
Allow investors to compare apples to oranges and call it "analysis"

Cap rates do NOT:

Predict future returns
Account for risk
Include financing costs
Reflect property condition
Tell you anything meaningful about actual investment returns

The Uncomfortable Truth

If cap rates actually mattered as much as "they" say, then:

Why do sophisticated buyers spend months doing due diligence?
Why do lenders require 200-page appraisals?
Why do deals fall apart after earnest money is at-risk?

Because cap rates are a starting point, not an answer.

They're the real estate equivalent of judging a book by its cover. Sometimes the cover is accurate. Usually, it's misleading. Occasionally, it's an outright lie.

What to Do Instead

Step 1: Throw away the cap rate.

Step 2: Underwrite the actual deal:

Real rents (not pro forma fantasies)
Real expenses (including deferred maintenance)
Real financing costs (this is how you're buying it, remember?)
Real hold period (you won't time the market perfectly)
Real exit assumptions (conservative)

Step 3: Calculate returns that actually matter (CoC, IRR, equity multiple)

Step 4: Stress test everything (vacancy +30%, rents -15%, exit cap rate +100 bps)

Step 5: If it still works, maybe—MAYBE—you have a deal.

The Snarky Summary

Cap rates are like asking "What's the asking price?" and thinking you've done due diligence.

They're a shorthand that everyone uses because it's convenient, not because it's accurate or useful.

The real estate industry has collectively agreed to pretend this metric matters because:

It's easy to calculate
Brokers can manipulate it
It sounds sophisticated
Everyone else uses it

But when your "7% cap rate property" turns into a 2% actual return (or worse, a loss), don't say nobody warned you.

At USLand, we show you BOTH the fairy tale numbers AND the reality. Cap rates included for comedic value only.

Find properties where the numbers actually make sense at USLand.com

Disclaimer: Past cap rates don't predict future suffering, but they're a good indicator.