Life beyond Cap Rates
Real estate veterans love cap rates, that intense but tenuous numerical relationship between a property’s net operating income (NOI) and proposed building value.
Remember the IRV formula? Divide income by a suitable cap rate, and voilà, there’s your price tag!
They’ve been around a long time (cap rates) – appraisers love them, as do most investors and longtime real estate brokers. They’re part of the commercial real estate shtick – the higher the cap rate, the less valuable becomes Baltic, Mediterranean or Marvin Gardens. But I still wonder if the luster of capitalization rates has waned?
To me, cap rates are incomplete, inconsequential, perhaps a worthy exercise for statisticians, but devoid of investment realism… the fact that almost all real estate can be leveraged, finance-able through commercial and private lenders, letting the investor or user preserve capital for immediate needs like improvements, equipment… or making additional property investments (St. Charles Place seems awful attractive at the moment). Why buy just one property when you can acquire two others at the same time? Why would a savvy investor waste all his cash on a single property, when (given today’s cheap cost of money) you could significantly increase your return on a lesser amount of capital you actually ante up?
To me and others like me, “cash in fist” is where the rubber meets that scary trek around the Monopoly board, passing jail and that gaggle of red hotels. How much am I making on my actual down payment? What is the cash flow after monthly mortgage payments? Does this property pay out more than U.S. savings bonds, my annual Christmas Club, or the B&O Railroad “deed” that costs only $200? Cap rates provide a snap shot, but one that is too grainy, blurred, or overexposed.
Ask a wealthy investor if he prefers sheltered income to a “seven-cap,” and you’ll start to see that real estate is multi-faceted – providing potential annual cash flow, but just as importantly, potential income tax savings if properly structured by a smart accountant or tax strategist. Moreover, real estate has huge “windfall” possibilities – most likely there’s sizeable appreciation down the road for those with vision and patience to wait it out.
As CBC Metro Brokers professionals, it’s up to us to learn more about our customers, their investment needs and aspirations, and determine how they measure the progress of their portfolio. Do they “speak” cap rate? Or something fancier like Internal Rate of Return? Today’s commercial specialist must be multi-lingual, and extremely flexible.