🔎 Why Cap Rate Doesn’t Tell the Whole Story in Commercial Real Estate 📉🏢
🔎 Why Cap Rate Doesn’t Tell the Whole Story in Commercial Real Estate 📉🏢
💰 Cap Rate vs. Cash Flow: What Smart Investors (and Lenders) Really Analyze 📊🔥
Why Cap Rate Doesn’t Tell the Whole Story
If you're investing in commercial real estate in Houston, Katy, or anywhere in Texas, you've heard it:
“What’s the cap rate?”
Cap rate is important.
But it’s incomplete.
As a commercial mortgage broker with Medallion Funds, I can tell you directly:
Lenders don’t finance cap rates. They finance risk, structure, and cash flow durability.
Let’s break this down properly.
What Is a Cap Rate?
Cap Rate (Capitalization Rate) =
Net Operating Income (NOI) ÷ Purchase Price
It measures unlevered yield — meaning it ignores debt.
Example:
·NOI: $500,000
·Purchase Price: $10,000,000
·Cap Rate: 5%
That’s fine as a pricing metric.
But here’s the problem…
1️⃣ Cap Rate Ignores Financing Structure
Cap rate assumes you paid cash.
Most investors don’t.
The difference between:
·65% LTV at 6.75%
·75% LTV at 8.25% bridge
·80% LTV with interest-only
·SBA 7(a) vs. conventional
·Bank vs. debt fund
…can completely change:
·Cash-on-cash return
·DSCR
·Exit flexibility
·Risk profile
At Medallion Funds, we routinely see:
👉 A 6.5% cap deal outperform a 7.25% cap deal
Because the capital stack was structured correctly.
Structure beats sticker cap rate.
2️⃣ Cap Rate Doesn’t Show Risk
A 7.5% cap rate might look attractive.
But ask:
·What’s the tenant credit quality?
·Lease term remaining?
·Are rents above market?
·Is there rollover risk in 18 months?
·Deferred maintenance?
·Balloon maturity timing?
Lenders analyze:
·Debt yield
·Lease maturity schedule
·Guarantor liquidity
·Exit cap assumptions
Cap rate alone does not measure durability.
3️⃣ Cap Rate Doesn’t Reflect Growth
Two identical cap rates.
Very different futures.
Example:
Property A:
·Static rents
·Tertiary market
·Limited population growth
Property B:
·Houston MSA growth corridor
·New residential rooftops
·Retail pad absorption
·Medical expansion nearby
Same cap rate.
Completely different appreciation curve.
Markets like Katy, Fulshear, and West Houston behave differently than flat-growth metros.
4️⃣ Cap Rate Doesn’t Account for Leverage Strategy
In commercial mortgage underwriting, we care about:
·DSCR
·Debt yield
·Interest coverage
·Refinance risk
·Prepayment structure
A deal with:
·1.50x DSCR
·Strong debt yield
·Corporate tenant
Will finance more efficiently than a higher cap rate with:
·1.15x DSCR
·Weak tenant mix
·Short lease terms
That directly impacts IRR.
5️⃣ Cap Rate Doesn’t Predict Exit
Exit cap expansion is real.
If you buy at:
·6.0% cap
But exit at
·7.25% cap
Valuation compression can erase years of cash flow.
Sophisticated investors model:
·Stabilized refinance
·Cap rate sensitivity
·Interest rate cycle
·Debt maturity wave
That’s the lens lenders use in 2026.
What Lenders Actually Look At
When we structure loans at Medallion Funds, we analyze:
✔ Debt Yield
✔ Global Cash Flow
✔ Lease Term & Credit
✔ Liquidity & Net Worth
✔ Exit Strategy
✔ Market Depth
Cap rate is just one input.
The Bottom Line
Cap rate is a pricing metric.
It is not:
·A risk metric
·A financing metric
·A growth metric
·A strategy metric
Smart investors ask:
“How does this deal perform under stress?”
If you want to structure a commercial mortgage properly — or evaluate a deal beyond cap rate — that’s exactly what we do.
📞 Let’s analyze the structure, not just the headline yield.
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© 2023-2024 Bill Rapp, Medallion Funds LLC, Director of Capital Advisory
