Rate your cap rate knowledge.What is a cap rate? It is simply the net operating income Operating Income The profit realized from a business' own operations. Notes: This would not include income from things such as investments in other firms. Also referred to as operating profit or recurring profit. (NOI NOI Net Operating Income NOI Notice of Intent NOI Nation of Islam NOI Notice of Inquiry NOI Neuro Orthopaedic Institute NOI New Organizing Institute NOI Notice of Interest NOI No Offense Intended NOI National Olympiad in Informatics ) of the property (before any debt service) divided by the price, which equates to a percentage rate of return if the investor were to purchase a property with no debt (all cash). Supply and demand and the cost of debt are two factors that affect cap rates in a market place. The cap rate is one of the primary determinates of pricing for investment properties. A direct correlation Noun 1. direct correlation - a correlation in which large values of one variable are associated with large values of the other and small with small; the correlation coefficient is between 0 and +1 positive correlation exists between market cap rates and current available interest rates for debt on investment properties. The climate in which interest rates are lower than cap rates is called a positive leverage market--the more one borrows, the higher the return on investment. When interest rates are greater than cap rates, the market is in a negative leverage scenario---the more one borrows against a community, the lower the rate of return is on the investment. It is also important to understand that the primary advantages of real estate over other investment types are leverage and tax advantages. Most real estate investors A real estate investor is someone who actively or passively invests in real estate. An active investor may buy a property, make repairs and/or improvements to the property, and sell it later for a profit. want leverage as much as possible because most advantages in owning real estate come with leverage. Like any other investment type, real estate is driven by supply and demand. Investors in real estate normally have a certain threshold of investment return they are willing to accept, depending on the asset and the current market. As interest rates decline and the cost to borrow Borrow To obtain or receive money on loan with the promise or understanding that it will be repaid. decreases, investors are willing to accept lower rates of return on their cash because other investment vehicles offer lower returns. As interest rates decline, two market forces work to drive an increase in real estate prices: 1. Cap rates are decreasing with interest rates; and 2. Investors are willing to accept a lower rate of return on their money. Conversely con·verse 1 intr.v. con·versed, con·vers·ing, con·vers·es 1. To engage in a spoken exchange of thoughts, ideas, or feelings; talk. See Synonyms at speak. 2. , in a rising interest-rate environment, the opposite is true. When more options exist for investors to achieve a greater rate of return and the cost of debt increases, cap rates increase and reduce the price an investor is willing to pay for an asset. In conjunction with these effects, the market also plays an important role in cap and interest rates. The higher the market demand is in a particular market, the lower the cap rates tend to be. Lower cap rates have a positive effect on prices. Alternatively, in a weaker market with lower demand, cap rates rise and values decrease. * CAP RATE CALCULATION N01 = $100,000 Price = $1,200,000 Cap rate = $100,000/$1,200,000 Result: Cap rate = 8.3 percent Tim O'Brien Tim O'Brien can refer to:
HFO High Frequency Oscillator HFO Heavy Furnace Oil HFO Hole Full of Oil (oil exploration slang) Investment Real Estate. He can be reached at 503/241-5541 or tim@hfore.com. |
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