Opportunity Cost

Opportunity cost is the return you give up by putting money into one investment instead of the next best one. A cap rate means little on its own. It becomes a decision when you compare it with what the same cash could earn elsewhere at similar risk.

If a Treasury note were paying 4%, $500,000 in it would earn about $20,000 a year with no tenants or repairs. The example property's $28,892 of NOI beats that by about $8,900, and the question is whether that margin pays for the vacancy risk, the work and the cost of selling later.

This is the logic behind the risk premium built into every cap rate. Investors demand more than the safe rate because property income is less certain. When safe rates rise, the opportunity cost of owning property rises with them.