Cap Rate Explained (Plus a Formula I Like Better to Analyze Investment Properties)
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- เผยแพร่เมื่อ 28 มิ.ย. 2024
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In this video, you'll learn what a cap rate (aka capitalization rate) is and how to use the basic formula. You'll also see examples of how a cap rate can be helpful for real estate investors. Finally, you'll get a bonus lesson on a slightly different formula called the unleveraged rental yield and how it can be used as an analysis tool for investment properties.
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COMPANION ARTICLE WITH GRAPHS & STATS: Cap Rate Explained (And Why It Matters With Rental Properties) - www.coachcarson.com/cap-rate/
TIMESTAMPS:
0:00 - Intro
0:20 - Cap rate definition and formula
5:10 - Cap rate basic example
8:23 - Measure of risk
13:30 - Property Valuation
14:34 - Example - Constant cap rate
17:37 - Example - Falling cap rate
20:38 - Example - Rising cap rate
23:05 - What's a good cap rate?
25:46 - Unleveraged rental yield
27:58 - Rental yield example
31:17 - Key Takeaways
32:46 - Closing
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This is great. Such a better more practical explanation than the other "guru's" give. Really impressed with your channel.
Thank you, Jeff. Just a real investor here, so I'm happy not to be in guru category;)
Hands down the best explination of how cap rates work. This video truly taught me the ins and outs of cap. Thank you!
Great to hear! I appreciate the feedback.
Great vid!
Excellent!!! Thanks
Excellent content
very helpful thanks! Music in the background distracting and not needed.
Noted! Thank you.
Thank you Coach. Looking forward to IRR video
Thanks Easha! IRR video coming soon.
Awesome video! I'm currently reading your book and gradually applying the principles.
Great to hear, Aaron! Thanks for reading the book.
@@CoachChadCarson Whats the name of the book?
Cap rates can be indicative of risk but they do not measure risk.
Please explain?
@@CoachChadCarson Let's take an example of two markets. Philly and SF. The last I looked Class A office was selling at a 7% cap rate in Philly and 4% in SF. If cap rates measured risk then you could say that Philly is almost twice as risky as SF. That is wrong. Both markets probably have the same national tenants and are established markets so in reality the risk level is probably about the same.
But why are investors paying $25 for a dollar of NOI in SF but only $14.29 for a dollar of NOI in Philly? Well cap rates only value NOI. That is all they do. But cap rates do not take all expenses into account. Capex can be a large expense that COMES OUT of your NOI. Rents were probably about $20SF in Philly and $80 sf in SF. So you would need about FOUR times as much sf to get the same NOI in Philly as SF. Now think of all the capex projects that are based on sf. Shoot, just think about exterior paint. $100,000 expense in SF but $400,000 expense in Philly. That is one reason for the difference in the cost of NOI.
So risk can be a component of the difference in cap rates but they do not measure risk, they measure value.
That makes sense. Good explanation with the two markets and different cap ex requirements. Thanks.
Great explanation, Chad! I definitely like having my own quick tools to evaluate potential properties and agree that cap rate isn’t the only (or even the best metric) to use when evaluating properties.
Thanks for watching and for the feedback, Steven! 👍🏻
Thanks Chad. I loved the various scenarios. Definitely helps me understand that better.
Glad to hear it! Thanks for the feedback.
If the 50k increased the property value then why is not considered a capital expense instead of operational expense?
Do you include the original price or the current value for Cap Rate? How does a past refinance adjust the value? Thank you!
17:10 New to this and struggling with some concepts on cap rates….In the measure of risk section, you mentioned that a property that needs very little work= lower risk, lower cap rate.
If this is the case, in your value-add constant cap rate example, after executing the value add strategy would the new and improved property not by nature fall into a less risky i.e. lower “market cap rate bucket”?
Conversely, I have learned through other studies that generally, a property with below market rents would likely trade at a cap rate lower than the market rate as a buyer (due to Buyer be willing to pay more for potential to grow income), how does this concept fit as it seems contradictory to the above.
When you are looking at market cap rates are you looking at the P/L each deal to find the Cap rate or are you looking at gross cap rates and assuming 50% in expenses to get the net cap rate?
Some stocks move more than 5% in a day. Its seems like it takes too long to make money with rental properties. Vs. using margin in a brokerage account perhaps the advantage is lower interest and higher leverage to hold your position. I did the math and i think another good equation is a
Net Rent Multiplier to determine how many years to pay off mortgage with a tenant. Current Mortgage amount (div by) NIAF (annual). And the Opposite is
Cap Rate (with financing). NIAF (div by) current mortgage amount. Thoughts?
Coach Carson I'm a bit confused. Cap rate is Income - Operating Expenses (not incl finance, capital expenses, depreciation etc) / Purchase Price
1) Do you include in your Operating expenses and allowance for future capital expenses? You might call this a reserve allowance. Or is this excluded from Cap Rate calculations?
2) In your example of Unleveraged Rental Yield you show you use the same Cap Rate numerator divided by Total Costs. Am I to assume that total costs represents the Purchase Price + closing costs + initial repairs + capital improvements at time of purchase? Or am I not seeing this correctly
Hi Kim. Technically I think you'd leave out capital expenses or reserves from the operating expenses when you calculate a cap rate. This is more the textbook definition and what's used to value commercial properties. But you'll also see a lot investors informally use a "cap rate" formula - which I've clarified as an unleveraged rental yield - as a way to analyze the income return on your investment. In that case, I WOULD include capital expenses in my line item because that's a real cash outflow for me. And from your question, I would include all of those upfront costs - price + closing costs + initial repairs + initial capex at the time of purchase in my unleveraged rental yield calculation.
Thanks for this. It really helped me understand what I should look out for. This is a rookie question- do banks look at cap rate only when doing a refi and/or do they evaluate based on appraisal?
the appraiser, more than the bank, will look at and use cap rate. But the bank will use that appraisal - both on a purchase loan and a refinance loan - to decide how much they'll loan you. So, for that reason a cap rate will be important to your borrowing process.
Best video on cap rate I’ve seen
thank you Ankush!
Awesome
Lower cap rates is ideal and higher cap rates are bad or more risky .. is this utilized for multi-family and SFh
How can you tell A market b market and C market? What’s the indication
Great video! Well explained but I have tons of questions 😅
If you’re getting 27000 on cash flow, then you have to subtract a mortgage from that cash flow. Afterwards you will have nothing? If a property cost you $350,000, then mortgage would be at least $2500 to $3000 monthly. $30,000 to $36,000 a year.
If you look at it this way then you won’t make any money unless you increase the property value and sell it. Right? Or I’m missing something?
Until you sell it, there will be no cash flow cuz all of that cash goes back to lenders
please do more !!!
Thank you! New podcasts on Monday and shorter videos on Fridays.
Thanks, Coach! Yes please deep dive IRR and break it down from both sides as you did here on Cap Rate to show how to use as a purchase guide metric as well as a valuation metric on the back side. Thanks again!!!!
will do. Video on IRR coming soon!
Thank you Coach! Definitely, I would like you to do a video on how you use IRR for REI
IRR video coming soon! Thanks for watching, Damian.
Analyze IRR, please.
Great Video Carson thank you. Quick question, Current Operating Expense you had at $14,400 then at new Rent you had Operating expense at $19,200. Just wondering how you find the new predicted number when running this formula to see your rental yield? Thanks
For estimates I usually use a % of gross rent. So like 40 or 45%. But it varies a lot in real life.
Thanks for watching!
The NOI could also go down at the same time. 😵💫
Yep. that's true.
Please use a bigger board
😄
Thanks for the video! As for me video without background sounds is better to listen. Or you should make music sounds less. I did a lot TH-cam videos and found that backgrounds you need only if you do not speak. Please make some changes, try to listen yours videos on TV and on mobile phone with airpods. Thanks!
thank you for the feedback. It's very helpful. I'm going to work with my editor to make sure we're not playing sound too loudly.
@@CoachChadCarson it's very important to understand everything from the video and background sound something make information hard to understand. Especially when you are not native speaker like me. I like your podcasts on Spotify, because they are without background music. Thanks for both variants!
In the example of 15:10, wouldn't the amount of debt increase over time due to interest rates which would therefore lead to a decrease in profitability? According to your example, the $350K in debt will be much greater as time goes by.
The $25k or $35k net operating income can be used to pay that interest on the $350,000 mortgage. For example, if it was a 6% interest only loan, that's $21,000/yr ($350,000 x .06 = $21,000). So, there'd be $4,000/yr of net income after financing/interest costs. So, in that case the mortgage balance of $350,000 would stay the same. If you had an amortizing loan, it would actually go down (not up). Hope that helps.
@@CoachChadCarson Thank you!
Carson, are you in Canada? I just rented my first property in Edmonton Alberta with 400$ positive cash flow.
Congrats on your first rental! I'm actually in South Carolina, US.
@@CoachChadCarson Thanks for letting me know. Still a lot of the principles sounds similar. Taxes and a few other things are slightly different.