Interesting question but for many of those reading this article their first thought may actually be: What is a capitalization rate?
In the world of commercial real estate the way that an investor, or buyer of property, will evaluate that investment is through the simple equation known as the capitalization rate.
Simply the capitalization rate, or cap rate as it is commonly known, is calculated by taking the Net Operating Income of a property (NOI) and dividing it by the price of the property.
Cap Rate = Net Operating Income/Price of the Property
As an example if the NOI is $24,000 and the asking price or recent sales price is $300,000, then the Cap Rate is 24,000/300,000 which equals .08 or 8%.
If an investor were to buy this building given the criteria above his return would be 8% and, if financing were to be used, the rule of thumb would be that the cost of funds or mortgage rate would be below 8%.
In some areas of the country today, however, this has not necessarily been the case.
Some investors, spurred on by the availability of easy money worldwide, have been willing to buy property with a cap rate as low as 0% under the investment thesis that the capital appreciation of the building would be significant.
Put another way they are willing to buy at no immediate return, potentially incur the cost of financing unless they were paying cash, in order to enjoy the potential price gains that have been occurring over the past few years.
Sound familiar? If it does then you will recall the type of real estate buying (or speculating), particularly in the residential market, that went on before the financial crisis hit.
And now, according to a special report at MHNOnline, cap rates are at record lows.
Is it a problem? Some think it may be while others are not so worried
‘Lowest Cap Rates in History, Global Liquidity, Raise Fears of U.S. Commercial Property Inflation’
Miami-The flood of liquidity worldwide is leading to an increase in commercial real estate values, noted Ken Rosen, chairman of the Rosen Consulting Group. Rosen spoke at a luncheon presentation during the 2014 CREW Network Convention & Marketplace this week in Miami.
