Cap rate

A building generating $30,000 a year after expenses and costing $500,000 has a 6% cap rate. It lets you compare properties of different sizes on the same basis, before financing.

Low cap rates usually mean the market expects the area to appreciate; high cap rates usually mean higher perceived risk or a weaker location. Neither is automatically better.

It deliberately ignores your mortgage, which is where the deal is often decided. Two buyers of the same building have the same cap rate and completely different returns. Buy at a 6% cap rate with a 7% mortgage and the debt costs more than the asset earns - negative leverage, where the deal only works if rents or prices rise, which is a forecast rather than a purchase.

And recompute the net income yourself. Sellers quote cap rates on optimistic expenses, and four items are routinely missing: vacancy, management, maintenance and capital expenditure. Together they usually take 25 to 35% of gross rent, which turns an advertised 8% into something closer to 5.5% before a single repayment is made.