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Cap rate does not include repayment of loans (such as mortgage), and therefore does not represent reliably the annual balance. Why use cap ratio if another benchmark, such as ROI, provides similar information, but includes repayment of loans? There are many situations where ROI is negative and cap rate is positive, hence misleading.

In addition, using ROI (or rather, compound interest rate) as the benchmark, lets the investor compare RE investment vs. the stock market.

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    ROI does not include repayments of loans! Also, ROI would be negative if the expenses are more than the income on the property, if this was the case then the Cap Rate would be negative as well. I think you have all your concepts mixed up. – Victor Sep 24 '15 at 3:22
  • @Victor, I think ROI includes everything. What's the point in not including repayment of loans?? – Sparkler Sep 24 '15 at 3:25
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    Because as George mentioned loan repayments are a cashflow measure not a return measure. What you think is not what is right! – Victor Sep 24 '15 at 3:30
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    The interest reduces your return, repayments usually include interest plus part of the initial loan being paid off, which ends up increasing your equity in the property. This portion of the repayment is not included in return calculations such as ROI or Cap rate. – Victor Sep 24 '15 at 3:59
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    By increasing your equity by reducing your principal, you are actually reducing the interest payable and thus increasing the net return on the property. It is not just a technical term and it is not only relevant for tax purposes. – Victor Sep 24 '15 at 12:57
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Cap Rate is the yearly return NOT including your mortgage.

Everyone will finance the property differently. From 0% - 100% down. This is why Cap Rate is the best way to compare properties.

Once you include your finance it is then called Cash-On Cash Return (CCR).

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Cap rate includes any interest on the mortgage and not the repayments of the mortgage. Cap rate represents the net income which is the gross rent minus all costs, including the interest on the loan. Mortgage repayments form part of your cash flow calculations not your return calculations.

ROI is a calculation which works out your net income over the initial investment you made, which is you downpayment plus costs and not the value of the property.

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  • I still don't understand why use cap rate. – Sparkler Sep 24 '15 at 0:41
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    You would use cap rate to compare the net return based on property value - comparing one property to another based on return vs price. You would use ROI to compare your return on your money invested. – user9722 Sep 24 '15 at 2:11
  • But (1) cap rate rate is not "net return" and (2) why would I care about "some random benchmark" such as cap rate if what an investor is really after is ROI (or rather compound interest, which are net return)? – Sparkler Sep 24 '15 at 2:16
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    Read your own link, cap rate is calculated by dividing the net operating income by the current market value. You would care about the cap rate if you were looking to buy a property as it is a way to compare returns vs price of various properties you may consider to buy, so you might chose the one with the highest return via the dap rate rather than just the lowest price. – user9722 Sep 24 '15 at 2:59
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    @Sparkler - you can use what ever method you prefer, ROI is based only on the initial investments you have made, while Cap Rate gives a value based on current market price of the property, so if you are comparing against other properties with different asking price you can make a comparison. – Victor Sep 24 '15 at 3:26

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