Cap rates and why they are important

General Real Estate Investing
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multi-unit buildings offer some great ways to create more value in the mid-long term hold, such as rental increases and lower expenses with more efficient management. Both things help increase value without having to spend a dime on repairs or capital expenditures.

I see this all the time, but I’m afraid it’s mostly guru nonsense. Rents are set by the market, not by the whims of the owner. If you buy a property that has sub-market rents, then yes you can raise rents and raise the value. What you didn’t say is that rents MUST go up over time just to keep up with inflation. In addition, rents can and do go down as well as up. It all depends on the economy (supply and demand). It is nice to say that you can improve the management and decrease the expenses, but that only really applies if the building is being mismanaged.

The truth is that it’s all fine and dandy to spout cap rates, but what really matters is cash flow and equity. I don’t care what the cap rate is if I’ve got money at the end of the month and my net worth is increasing. You can’t eat cap rate, but you can try!

Mike

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Market caps rates are not a good tool when looking at a property from an investment stand point. Lenders like them because it helps them gauge what the over all market is going compared to your investment. What you need is an investment cap rate. The former is a combination of your cost of capital, equity position going in, purchase price, growth, selling expenses and required equity return.

I would recommend that if you are new or lack the knowledge of how value works, that you consult a local expert. If you are interested in the subject research discounted cash flows for income properties, one period capitalization method (easiest and most peoples favorite).

Good Luck!!

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The point of my post is to stress the importance of understanding your market or submarket. It’s obvious that you must evaluate an asset based on your overall rate of return but it shouldn’t end there.

Lenders use it to evaluate the risk associated with the investment. Investors should be using it in the same way.