Using Cap Rate to Value Properties

Jun 14 08:10 2011 Stew Spence Print This Article

Learn the secrets the pros use to value properties by using the cap rate.

Direct Capitalization Formula Perhaps half of all investors use this next rule of thumb to rule out properties that won't work for them. It's commonly called Direct Capitalization or the "Cap Rate" approach. Some investors know this Capitalization Rate ("Cap Rate") or Discount Rate by other names,Guest Posting such as the Hurdle Rate or the Opportunity Rate. IRV Rule of Thumb The "Cap Rate" is typically talked about among realtors as the IRV rule of thumb: Income divided by Rate equals Value. The lower the discount rate, the higher the value and, inversely, the higher the discount rate, the lower the value. It's slightly confusing even in the real estate industry, because when appraisers talk about Capitalization Rate, they mean something entirely different than when investors use the term. An appraiser's capitalization rate is a thing of beauty. They use a Discount Rate that's part of their Capitalization Rate. They compute that discount rate very carefully from historic sales, which means that they're always behind the times-by months or even years. Much of the total "Cap Rate" that they use is what investors think of as the actual "Cap Rate". However, they call it the Discount Rate. The Discount Rate is a large part of what investors count as the "Cap Rate", with a small piece included termed the Capital Return Rate. This element is used to differentiate between two buildings of different ages. For example, when comparing two 40,000 square foot buildings that each has 10 tenants, gross income of $100,000, and a 7% vacancy rate, you might think that they are very comparable properties. However, once you find out that the first building is 100 years old, while the second one is only 15 years old, it becomes a different situation. You might agree with the appraiser that the 100-year-old building is worth less than the building that's only 15 years old. Logically, the older building will fall down before the newer one, so that small component of the appraiser's Capitalization Rate, the Capital Return Rate, factors into this element. Some of the "Cap Rate" is return on investment, so appraisers also take that into account when appraising your property. They use a Capitalization Rate that's composed of two elements: • Discount • Capital Return Real estate investors only use the Discount Rate, which is the raw return for the first year that they'd like to get on their investment. Some investors think of it as the rate of return they're getting on that investment. So if you want 10% on your investment and the property is producing $100,000 of NOl, you can afford to pay $1,000,000 ($100,000 divided by.10). If you needed 12%, you would only pay $800,000 ($100,000 divided by.12). Key Point The higher the Cap or Discount Rate, the lower the value of that property. To earn 15% on your money, you should be willing to pay less than if you want only 10%.ATTENTION: Here's how to invest for phenomenal secured returns in large-scale commercial r.e. projects all across the country without shouldering all of the cost or risk yourself. Take advantage of the Infinite Returns™ program and invest together with the members of commercial real estate buying group HIS Real Estate Network. Join Stew Spence and the Real Deal Team for an upcoming educational presentation online to get information or to get started now:

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About Article Author

Stew Spence
Stew Spence

In 1989, Stew Spence became a full time real estate investor, and has bought, sold or been on the business end of hundreds of r.e. transactions, both large and small, numerous diverse types of transactions totaling over $40,000,000 including commercial, mobile home park, multi-family, condo conversions and land development projects with a specialty in foreclosed properties needing rehabilitative construction. Now semi-retired, Stew is still an active investor and has trained thousands to succeed with real estate. Today, he is also retained as a Board of Advisors member with HIS Real Estate Network, residential and commercial real estate buying group.

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