What Commercial Real Estate Investors Should Know About Rate Cap

Maximum rate or capitalization rate or cap is simply the ratio of annual rental income of the property purchase price. This number is often shown commercial real estate listings. So you need to know the jargon, if you want to invest in commercial property. It is commonly a number between 3% to 10%.

For those investing in the stock market, the maximum rate is the equivalence of the inverse of P / E ratio. Thus, a cap of 5% is equivalent to P / E ratio of 20. The main difference is the gain in real estate is real, while its accounting gain on the stock exchange, where salaries can be reinstated years down the road!

The higher the cap the higher income rental property and therefore produces less money for down payment. Experienced investors often look at the cap to block the property with a low rental income. Some investors prefer property with the cap that is higher than the rate of interest they pay on the loan. In this way they know that collect more than the tenants pay the bank.

When the property has a high vacancy rate, broker ads often show proforma (or potential) cap instead of capturing the attention of investors. We use the following example to illustrate this point. A property is listed for $ 1M and 90% for rent. He leases with a gross actual income gross of $ 30K and $ 90K/year annual spending. Assuming that the pro forma income of $ 110K/year when it is 100% leased at market rent higher. Then 3 different ad brokers can view 3 different maximum rates for the same property:

o The first broker may use NOI (Net Operating Income) of $ 60K/year ($ 90K gross income net of expenses of $ 30K) and then the net rate of CAP was 6%. This intermediary calculates the cap the way it should be.
Ø The second broker may use the gross income of $ 90K, and so the gross rate of CAP has been 9%.
o The third mediator may decide to use the pro forma income of $ 110K to attract the attention of investors and therefore the rate of PAC pro-forma is 11%!

As an investor, you need to know what chapter, such as net, gross or proforma the broker uses. Otherwise, you too can offer for the property. At the same time, when you tell your broker to search for properties with a maximum rate of course, make sure that the broker knows what the maximum rate you have in mind.
The return on an investment property sales come from 4 sources: appreciation, cash flow, ie the maximum rate, depreciation (tax loss), and reducing your mortgage payments to principal. If you invest in property "right", the largest chunk of investment return should come from the appreciation. There is often a conflict between the cap rate and the potential for appreciation. The properties that offer strong potential for appreciation, for example, new properties or those in good position tend to have a lower cap rate. On the other hand, the properties that are in poor condition, or who lease land are much more difficult to sell. As a result, the seller will seek to attract buyers with a rate higher maximum. If you see a property with a maximum rate unusually high in California, for example, more than 7%, you should ask yourself "what's wrong with this property?" It is likely that there is a valid reason why it is so high.

Is the property with the highest cap the "best" properties? The short answer is no. If the investment was so simple, it would need an investment advisor. Maximum rate should be one of several other factors that you consider whether you should invest in a property. It should not be the only factor. Furthermore, it is possible to improve the plug

o Increasing the employment rate.
Ø increase the rent when leases expire in progress.
Ø Negotiate for leases with annual rent increase.
or improve the property to attract tenants more exclusive.
o Reduce the costs not reimbursed by tenants.

In this way, it is possible to increase the maximum rate and consequently the value of your investment .......