Good morning! Today Peter is exploring Investing In Commercial Properties, let me know if you would like to guest post on Make Money Your Way.
The real estate investors have every reason to cheer! The market is looking up. Population growth has made it more profitable to invest in real estate business. The experienced investors are well aware of the market condition and vital aspects of property business. The novices, however, need to educate themselves regarding different aspects before risking their money in real estate business.
One key factor for successful real estate venture is cap rate. Unfortunately, it is often misunderstood by many investors. Before venturing out, cap rate is likely to be your first consideration. However, you can make a good use of it only if you have good understanding of what is meant by cap rate and how it can do value addition.
Cap rate is a trimmed form of capitalization rate and calculated as a ratio of the first year’s net operating earnings and purchase price of the property. The ratio integrates three variables – interest rate percentage, net operating income and value and expressed as a percentage. Investment measure is an indication of what percentage of cash purchase an investor is likely to gain in the first year.
The capitalization rate percentage and your net operating return in the first year are directly correlated with each other. An amazing correlation can be found in another aspect. If interest rate drops, the rate is less likely to follow the decline. However, if interest rate slides up, the rate will soon to follow the footprint.
What is the significance of cap rate?
This question is more related to the application of cap rate. The investors use this rate to quickly calculate the return from an investment. This helps them decide whether a real estate property is worth a consideration. You can also apply cap rate to typify the marketed assets. For example, if you know the sale price and cap rate, it will take only a few minutes to determine your estimated net operating income.
Is there any shortcoming of cap rate approach?
There is no doubt that cap rate is important but only if it is accurate. You should know the pitfalls of cap rate approach. Many unscrupulous property market dealers overrate it to exaggerate the investment potentials. In some cases, wrong net operating income assessment is the reason for faulty cap rate calculation. The wrong calculation and inflated figure make it more unlikely for you to discern the actual investment potential.
To be a successful investor in real estate property business, you need to understand that cap rate, in spite of its high significance, does not reveal other details that are equally or more important to measure investment potentials. It does not consider your debt, taxes and other transaction expenses.
To be on safe side, you need to understand a target cap rate which is specific to your situation that involves your debts, taxes and cash return estimation. An accurate result can guide you in making safe investment that is immune to market trends. The advantage of owning a calculation procedure is your estimation regarding property valuation and net return calculation will be more closure to accuracy.
Our other real estate posts:
Have you invested in commercial property? Would you like to?
This post was featured on the Common Cents Wealth, thank you!