Cap Rate Useful Or Not?

BethE profile photo

I have come across a property with a cap rt of 22%. Does this mean anything significant? The neighborhood is fair and I am wondering if this as a good deal...

Comments(16)

  • edmeyer24th November, 2003

    I personally do not like using cap rates for decision making. I prefer working with dollar values rather than ratios. I would do an analysis using a spreadsheet. That being said, if your property has a market value of $100K, at 22% cap your Net Operating Income is $22,000. If this property is financed at 6.5% fully amortized over 30 years, your annual debt service is $7,584.82. This investment would put $14,415.18 per year in your pocket. You can scale these dollar amounts by taking the ratio of the market value divided by 100,000 and multiply this ratio by all of the above dollar amounts. This looks like a good deal to me, but you may have different standards. You are getting more than 70% return on your investment if you put 20% down. This is from cash flow alone.

  • Marcher24th November, 2003

    On the surface it sounds like a potentially great deal. Cap rate is high enough to be suspicous perhaps? Are the figures yours, or were they provided by the owner/agent? What type of property is it? Are there any reasons why it would be underpriced (high vacancy, half the insides destroyed by fire, needs a lot of fixing etc).

    I would check it out very carefully, but if you like the looks of it you might want to get it under contract with a contingency to inspect.

    I think (others might like to comment) that generally 10%+ is considered a healthy cap rate for people looking to buy.

  • GFous25th November, 2003

    Agree with above. I would challange a 22% cap rate. My guess is that this is either wrong, a lie, or a dream.

    Perhaps they ignored reserves,management fees. etc.

    Anyting abouve 10% is a buy today. ( if it is calculated correctly)
    [addsig]

  • BethE25th November, 2003

    Thanks everyone,
    The cap rate was my own computation. They claim the property isnewly renovated. The neighborhood is rough but they need a place to live too. The rents are low and it still makes sense. I will check it out but I think the neighborhood scared them off. It is going thru a rejuvination recently so I could really capitalize on that down the road. I know not to count on it though. Like I said, even if the neighborhood doesn't improve I could still do well. I'll probably get a property mgr though ( I can be tough but I'm only 5'4"...not THAT intimidating!
    Any other advice?

  • aurera25th November, 2003

    Quote:
    On 2003-11-25 09:34, BethE wrote:
    I'll probably get a property mgr though ( I can be tough but I'm only 5'4"...not THAT intimidating! <IMG SRC="images/forum/smilies/icon_lol.gif">
    Any other advice?

    Before you commit to buying the place (ie: make an offer) contact property mgrs in the area FIRST. Some of them will not touch props in neighborhoods which they feel is unsafe or if the condition of the property is not to their standards.

    Good luck
    [ Edited by aurera on Date 11/25/2003 ]

  • hibby7625th November, 2003

    Cap is a good way to analyze properties, as long as you calculate it correctly (garbage in, garbage out) and realize the limitations of the equasion.

    Generally speaking, the higher the cap (say over 10) the higher the risk. You can find properties with very high caps, but they'll be in gang-infested areas, condemned, be illegal-non conforming, have a bio hazard on the site, etc. For that property I'd get it under contract, do your due diligence, and make sure to get an inspector out there, check with the city zoning, do a thorough title search, and evaluate the comps.

  • edmeyer25th November, 2003

    Beth,
    Be a little careful on this one. I am guessing this is multi-unit since you don't see cap rates thrown around often for single family residences. Match your number against the ones I gave you in my previous posting.

    If it is multi-unit, I would have the seller show you the books as a condition of purchase. The variablity of costs is much larger with larger buildings.

    The other issue is the neighborhood. Bad neighborhoods can be management headaches. Are you intending to manage this yourself?

  • BethE25th November, 2003

    Hi all,
    Well I saw two properties today with cap rates way up there.
    #1 - 15units - recently renovated - weekly rentals - has a motel license so if they don't pay, landlord/tenants act doesn't apply...just call the sheriff
    #2 - 12 units - falling apart - some vacant in a poor neighborhood - needs tlc - all units on separate meters ( that could be nice) - should I entertain a rehab and sell these as condos?

    Any advice...normally I would walk...but since I haven't really found my niche I'm considering everything.

  • TRAVELHUNI25th November, 2003

    Any of you seasoned comm. investors care to share any forms/spreadsheets/analyses that figure Cap or profitability? (for us newbies)
    We'd appreciate it.

    Thanks

  • mcdok25th November, 2003

    I like return on invested cash. Estimated annual net cash flow / down payment. I also like Asking Price/Gross annual rents. If you rate all of your potential investments by a couple or three of these investment factors, it is easier to determine the best investment vehicle, plus it gives you some ammunition if the asking price looks a bit high compared to other properties.

  • InActive_Account25th November, 2003

    Just remember this one thing very, very cleary..."Buyer Beware". This says it all. If you find a deal that is rough and can be worked out given the right project management, financing and time table - then work the deal! Otherwise move onto to other opporunities and never look back.

  • GFous10th December, 2003

    Quote:
    On 2003-11-25 22:45, TRAVELHUNI wrote:
    Any of you seasoned comm. investors care to share any forms/spreadsheets/analyses that figure Cap or profitability? (for us newbies)
    We'd appreciate it.

    Thanks


    Cap rate calculation is VERY Simple.

    Arrive at the Net Operating Income. This is the annual income you will recieve BEFORE any debt service but includes a management fee (whether or not you pay one) a vacancy and credit loss, and a reserve for repairs number.

    Divide this number by the ask price.

    SO: if NOI is $9000 and price is $100,000 CAO rate is 9%

    Gregg
    [addsig]

  • DavidMc11th December, 2003

    BethE, the 22% cap rate is high. Rules-of-thumb can be dangerous. Most commercial properties trade in the 10% area. The higher the risk the higher the cap rate. I have posted a complete analysis of a commercial property on****Must Reach Freshman Investor status before posting URL's***

  • Shirley11th December, 2003

    Just a piece of advice on shaky neighborhoods....Shaky neighborhoods are great to buy and hold in (as long as the numbers work) I like knowing I can still have a nice cash flow even if I charge the cheapest rent out there. My advice is to SCREEN, SCREEN, SCREEN those tenants! None of my tenants have good credit, but I never rent to anyone that's been evicted (no matter what pathetic excuse they have!)

    I look at it this way.....if the economy is good, rents will go up. If the economy is bad, the more "well off" people who want to tighten their belt will move to a lower-end place....so there is a constant supply of tenants to fill my vacancies. A typical ad in the newspaper for a vacancy I have will yield about 75 phone calls the first two days. I always keep in mind that just because I would never live there doesn't mean it just might be the best place someone else has ever lived in!

  • thoward18th December, 2003

    I would be very careful, it depends if you have management experience or not. Why are they asking so little of the property?

  • BethE18th December, 2003

    Property under contract ( by someone else) on the 14 unit. The 13 unit was a mgmt nightmare. Thanks for the input. It brought me back to earth...sometimes you feel like you can do it all and forget the "preferred property" or goal to investing. I decided this was not for me. Thanks!!!

Add Comment

Login To Comment