The Capitalization Rate or Cap Rate is a ratio used to estimate the value of income producing properties. Put simply, it is the net operating income divided by the sales price or value of a property expressed as a percentage. Investors, lenders and appraisers use capitalization rates to estimate the purchase price for different types
of income producing properties. A market cap rate is determined by evaluating the data of similar properties which have recently sold in a specific market. It provides a more reliable estimate of value than a market Gross Rent Multiplier since the cap rate calculation utilizes more of a properties financial detail. The GRM calculation only considers a properties selling price and gross rents. TheCap Rate calculation incorporates a properties selling price, gross rents, non rental
income, vacancy amount and operating expenses thus providing a more reliable estimate of value.
P.S. Not my words but how I understand the concept. I grabed this from the Web.[ Edited by wintent on Date 09/15/2003 ]
CAP rate. The rate of interest which is considered a reasonable return on the investment, and used in the process of determining value based upon net income. It may also be described as the yield rate that is necessary to attract the money of the average investor to a particular kind of investment.
Now thats the BS answer straight out of the book.
But be carefull cause if you manipulate things correctly, by adjusting interest rates and increases in future rents and reduction in management costs etc. you can influence this figure like crazy.
Example. In Los Angeles about 20 years ago masses of Japanese Companies came to town and started buying up major office buildings etc. As an MAI appraiser at that time I did most of the appraising. My suggested prices to purchase were around 8 to 10 times the stated income. They ignored my advice even though my Japanese was passable and I played a really great Shakuhachi and listening to their Sansi broker they bought at about 20 times the stated income. As they informed me with many formal bows and hissed breathing I did not have a clue, they knew what was coming in world economics and these were bargains.
Hi Dozo. During the past six years various companies here in Los Angeles have been buying them back and the buy back is again about 8 times the gross rental. The Japanese really took a bath. For a time I felt that maybe I was wrong, so I spent about six months in heavy research Historical Economic Trends. I was right, but that did not save the nice Japanese. Does this explain? Lucius
Thank you both for your replies. What would be considered a good and or a great cap rate?
Lufos,
If I understand you right, if a sales price is below 8 to 10 times the gross rents it should work with proper management and funding? EX. rents x 8 or 10 x 12 months or am I misunderstanding?
Lufos is sure right, the cap rate can be played with.
Be aware of the commercial RE. that's offered at a real high cap rate, as that's often the sign of a bunch of deferred maintance.
That is, the owner hasn't been putting any of the gross rent back into the property to maintain it, and that's making the NOI (net operating income) look better than it should be.
No property can go forever without painting, other maintenance, and if you buy one that's been long ignored, YOU'LL do the paying, by lost rents & poor tenants.
There are many factors for vacancy rates. for instance area, median income, type of property, etc. I would suggest finding like properties in that area and asking the typical vacancy rate for those. In pinellas county florida for multifamily, the vacancy rate is 5-10%, for retail it is roughly the same. If you factor in a 5-10% rate you should be right on the mark generally speaking, but do your research places like Youngstown OH, for instance has a vacancy rate that is triple that due to the lowered income and sparcity of what is left of the residents there.
The cap rate is supposed to supply you with a figure. How much interest return on the investment can you make? 10% is nice, 8% is a little safer. Of course the one item we all do not consider. The Headache Factor. That can be adjusted somewhat by proper assignment of management. Your onsite manager. I used to (in highly combative closed ethnic areas) put them on a percentage of collections. Keeps them honest no short time rentals in the vacancies etc.
Now that reduces the headache factor. Lots of others things too. Everything is figured out on a yearly basis. Remember these are only approx's. Each deal is slightly different. A present time example. Two properties located in the slummy area I live in. We had an influx of Albanians and shortly afterwards some Slavic/Croatians. Did we mix them alltogether. No. We put them each in a seperate building and designated in each group a senior family member to represent them all in our monthly meeting to influence friends and control people. This is called for those who read their history, The Bismark Solution.
Bismark had a solution to the ongoing continual problem of the Balkans. Never fight a war there. Merely surround the area of conflict and wait til they get thru killing each other, then deal with the winners. Worked for him and it works for us. As you are perhaps aware California in spite of its slightly odd way of doing things is a Mecca for newly arrived immigrants. I think they all want to be movie stars. Perhaps we should all get together and open up the Old Schwabs Drug Store. Advertise "Come here and get discovered, talent secondary." I must figure a CAP rate on that little venture. Cheers Lucius
The Capitalization Rate or Cap Rate is a ratio used to estimate the value of income producing properties. Put simply, it is the net operating income divided by the sales price or value of a property expressed as a percentage. Investors, lenders and appraisers use capitalization rates to estimate the purchase price for different types
of income producing properties. A market cap rate is determined by evaluating the data of similar properties which have recently sold in a specific market. It provides a more reliable estimate of value than a market Gross Rent Multiplier since the cap rate calculation utilizes more of a properties financial detail. The GRM calculation only considers a properties selling price and gross rents. TheCap Rate calculation incorporates a properties selling price, gross rents, non rental
income, vacancy amount and operating expenses thus providing a more reliable estimate of value.
P.S. Not my words but how I understand the concept. I grabed this from the Web.[ Edited by wintent on Date 09/15/2003 ]
Dear John and Kathy,
CAP rate. The rate of interest which is considered a reasonable return on the investment, and used in the process of determining value based upon net income. It may also be described as the yield rate that is necessary to attract the money of the average investor to a particular kind of investment.
Now thats the BS answer straight out of the book.
But be carefull cause if you manipulate things correctly, by adjusting interest rates and increases in future rents and reduction in management costs etc. you can influence this figure like crazy.
Example. In Los Angeles about 20 years ago masses of Japanese Companies came to town and started buying up major office buildings etc. As an MAI appraiser at that time I did most of the appraising. My suggested prices to purchase were around 8 to 10 times the stated income. They ignored my advice even though my Japanese was passable and I played a really great Shakuhachi and listening to their Sansi broker they bought at about 20 times the stated income. As they informed me with many formal bows and hissed breathing I did not have a clue, they knew what was coming in world economics and these were bargains.
Hi Dozo. During the past six years various companies here in Los Angeles have been buying them back and the buy back is again about 8 times the gross rental. The Japanese really took a bath. For a time I felt that maybe I was wrong, so I spent about six months in heavy research Historical Economic Trends. I was right, but that did not save the nice Japanese. Does this explain? Lucius
Thank you both for your replies. What would be considered a good and or a great cap rate?
Lufos,
If I understand you right, if a sales price is below 8 to 10 times the gross rents it should work with proper management and funding? EX. rents x 8 or 10 x 12 months or am I misunderstanding?
Thanks again,
John and Kathy
Cap rate of 10 is good, to me. The higher, of course, the better.
Just one comment here.
Lufos is sure right, the cap rate can be played with.
Be aware of the commercial RE. that's offered at a real high cap rate, as that's often the sign of a bunch of deferred maintance.
That is, the owner hasn't been putting any of the gross rent back into the property to maintain it, and that's making the NOI (net operating income) look better than it should be.
No property can go forever without painting, other maintenance, and if you buy one that's been long ignored, YOU'LL do the paying, by lost rents & poor tenants.
Thanks for the additional input and information. It is greatly appreciated.
Thanks again
John and Kathy
I would recommend a little more education into the area of investments you are seaching to avoid a financial mistake
what % do you normally allocate for vacancy losses and operating expenses?
There are many factors for vacancy rates. for instance area, median income, type of property, etc. I would suggest finding like properties in that area and asking the typical vacancy rate for those. In pinellas county florida for multifamily, the vacancy rate is 5-10%, for retail it is roughly the same. If you factor in a 5-10% rate you should be right on the mark generally speaking, but do your research places like Youngstown OH, for instance has a vacancy rate that is triple that due to the lowered income and sparcity of what is left of the residents there.
Good Luck,
Kyle
John and Kyle are both correct.
The cap rate is supposed to supply you with a figure. How much interest return on the investment can you make? 10% is nice, 8% is a little safer. Of course the one item we all do not consider. The Headache Factor. That can be adjusted somewhat by proper assignment of management. Your onsite manager. I used to (in highly combative closed ethnic areas) put them on a percentage of collections. Keeps them honest no short time rentals in the vacancies etc.
Now that reduces the headache factor. Lots of others things too. Everything is figured out on a yearly basis. Remember these are only approx's. Each deal is slightly different. A present time example. Two properties located in the slummy area I live in. We had an influx of Albanians and shortly afterwards some Slavic/Croatians. Did we mix them alltogether. No. We put them each in a seperate building and designated in each group a senior family member to represent them all in our monthly meeting to influence friends and control people. This is called for those who read their history, The Bismark Solution.
Bismark had a solution to the ongoing continual problem of the Balkans. Never fight a war there. Merely surround the area of conflict and wait til they get thru killing each other, then deal with the winners. Worked for him and it works for us. As you are perhaps aware California in spite of its slightly odd way of doing things is a Mecca for newly arrived immigrants. I think they all want to be movie stars. Perhaps we should all get together and open up the Old Schwabs Drug Store. Advertise "Come here and get discovered, talent secondary." I must figure a CAP rate on that little venture. Cheers Lucius