What You Should Know About the Cap Rate

[porter]

Good discussion of the cap rate and commercial real estate valuation:

http://www.propertymetrics.com/blog/...6/03/cap-rate/


Thoughts?

[charliebrown]

Re: What You Should Know About the Cap Rate

thanks for posting. no thoughts, i'm not knowledgible enough to add any input.

[c1ue]

Re: What You Should Know About the Cap Rate

Cap rates are very commonly used, but I'd think a major hole with using it is that property values and interest rates have significant correlation.

Why does this matter? Well, when interest rates in the '80s were 20% - I don't think anyone thought a 10% cap rate was a good investment. In comparison, these days a 6% cap rate is considered decent by some.

Equally of concern is property valuation. Cap rate basically assuming the property either stays the same value or goes up in value. If the property goes down in value, then a high cap rate (especially 6%!) will have a hard time overcoming the capital loss.

[charliebrown]

Re: What You Should Know About the Cap Rate

The article did mention that the cap rate should be compared to risk free return. So in the 80's with a short term rate in the teens??? One would not buy a building with a cap rate of 10%.

However to your point. Since real-estate is usually a leveraged deal (you take out a loan), If interest rates are high the property will probably decrease in value because the pool of available buyers for your building decreases as interest rates go up. Also a new buyer will have to use more of the property income to service the mortgage. So even if the cash flow remains the same for you assuming a constant rent stream and your fixed intial investement, if you want to unload the property you will not be able to get your principle back out.

Lets see how those recently rising home prices fare if the interest rate goes back up to 5 - 6%.

[c1ue]

Re: What You Should Know About the Cap Rate

The article did mention that the cap rate should be compared to risk free return.

The problem is - nothing is risk free these days. Even if the amount of dollars you'll get back are guaranteed, the amount of stuff you can buy with those dollars is not.