Considering Cap Rates In Today’s Market - Sun and Planets Spirituality AYINRIN
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If
an investor is considering what to look for in a real estate
investment, a cap rate is one of the first factors they review. They
want to know their return before debt service. You can find the cap rate
by taking the net operating income of a property and dividing it by the
purchase price. You can learn more about what factors determine cap
rates in the article “5 Factors that Help Determine Cap Rates.”
When
looking at cap rates, keep in mind that these figures are sensitive to
changes in the market. It can be helpful to consider other trends that
could impact the cap rates in your area. In the following sections,
we’ll look at several points to keep in mind when you research
properties and think about their potential return.
Cap Rates and Interest Rates
If
you look at cap rates for different properties, keep in mind that these
figures are very sensitive to interest rates. As mortgage rates have
rates have gone up during the last years, so have cap rates. Investors
today are typically looking for neural or positive leverage. That means
that the rate they are borrowing at is at the same level as the cap
rate, if not above.
I
remember early in the 2000s, some investors would actually accept a
lower return than what they were borrowing for. They did this because
they hoped they could make up ground by increasing the net operating
income. In other words, they felt that the upside would offset and
warrant this. Unfortunately, that didn’t’ play out in some cases, as
property values didn’t increase and investors had to pay high rates on
their debts. In some cases, they were unable to exit out of the
property. Today, investors seem to have learned from these past
instances and tend to look for neutral or positive leverage.
Establishing Your Returns
If
you take your net operating income and subtract your debt service, that
will establish your cash flow. If you divide your cash flow by the
amount of equity you have in the deal, that will be your cash-on-cash
return. If your debt service is less than the cap rate that you are
buying at, you will see that your cash-on-cash return will be higher
than the cap rate.
That’s
a very important function or benefit of real estate investing. If you
can get higher returns than what you’re borrowing at, you’ll essential
generate an income off that spread. In this way, you can build up a
portfolio and gain long-term returns on a property.
Other Valuation Metrics
While
it can be helpful to look at cap rates, bear in mind that they are not
the metric every investor uses. Many are focused on long-term value and
might be interested in the price per square foot of a place. These are
often easier to establish, as they are public information. Cap rates, on
the other hand, are not readily available. You can use privately held
data sources such as Costar to get this information. You can also work
with an investment sales broker who will have this data.
Once
you know the cap rate of a place, along with how it is determined and
the trends in the market, you’ll be able to get a better sense of the
return you can expect. You’ll want to pay attention to your tolerance
for risk, too, and take steps to make sure you’re not overleveraged.
Overall, working with a knowledgeable team can help you gain the
information you need to make an informed decision on an investment
property.
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