I diss agree. The cap rate comes in useful to find the current value of the property. The cap rate shows the correlation between the aking price to NOI. Make sure the property is worth the asking price.
Would recommend doing a video on modified IRR, as the standard IRR assumes the investor can reinvest all positive cashflows at the calculated IRR. Another alternative is to make sure you always consider your net money multiple or excess economic value add given some minimal acceptable return.
So many good insights in here. Negative leverage finally clicked that if a loan constant is bigger than cap rate its a negative situation. Also why low cap rates in hot markets are okay. Thanks Justin!
For single-family residential properties, people like to use "Monthly Rental Factors" so you could just use that with a multi-family a lot of the expenses are different from commercial and residential.
@@BreakIntoCRE Keep it up... build more subscribers. Don't give up... Meet Kevin specializes in sensationalism, perhaps you can think of a new approach to bring more viewers. I agree that your videos are most informative that give substance rather than fluff.
Thought provoking video but dangerous to say "don't really matter". Video makes sense if debt is not being used but in practice it almost always is. For good or for worse, cap rates are the core tool for appraisers and bank valuations so they in and of themselves establish value for lending purposes, hence they in and of themselves affect sale price. IRR is for your own internal metrics for what type of return makes sense for you as the investor... they don't move market prices like CR. Ie. If you bought a property at a 5 cap and several years later that areas market trended down to a 4 cap, if nothing else changed with regard to your NOI the increase in asset value and profit on sale would be extraordinary (so long as the buyer was using debt which should be assumed). Conversely if you bought at a 4 cap and property area trended up to a 5 cap, your asset could be worth less unless your grew the NOI by a significant amount. The point is this is an apple to orange comparison...CR are so embedded in the lending valuation system they matter tremendously to the ultimate goal of increasing IRR.
Just for transparency maybe you could do a video on the pitfalls of IRR and show how a series of cashflows can have multiple IRRs when the cashflows are non-conventional. Two or three lots of cash outflows as opposed to just the one at the beginning.
Answer: To bypass the risk of prospective buyers increasing the price solely due to Walt Disney's fame and/or intended use of the Real Estate, he decided to purchase all of the Real Estate in and around Orlando, Florida using several private Land Trusts.Dec 2, 2019
Could you please explain how you calculated the 6.01% loan constant from the 4.4% interest rate amortized over 30 years for someone who is just starting to wrap their head around these concepts? Also, how you derived the 5.98% cash on cash return from that?
Loan constant is calculated by taking the annual interest and principal payment and dividing by the loan amount. So it takes into account the principal portion of the payment as well and not just the interest on the loan which is 4.4% Cash on Cash is going to be the NOI after debt service divided by the equity amount. In this case you get a CoC that is lower than the cap rate which means you have negative leverage. Hope this helps
Very valid points. I’ll add 2 more: Deferred maintenance. There may be several hidden issues waiting to happen. If the seller isn’t talking about them, I just assume he’s never done them. And #2, net migration is important but so is shortage of and reliability of labor force. That’s true especially in a post pandemic world. The cost of repairs vary from buyer to buyer, depending on whether they have the capability in-house of doing the repairs or not. Now, my question is, in a post pandemic world, post great migration, how do you factor into your IRR appreciation; the scale seems to have shifted a bit towards emerging markets and a bit away from the big metro ones.
Can you do a video on: It all boils down to information. Specifically, the kind that tells where to buy real estate real cheap, knowing beyond a certainty, that it's going up, up, up in value. Walt Disney bought the land for his future theme park through trusts, Gee, I wonder why?
Oh, also do a video on our honorable States People in congress buying large blocks of stack in companies in markets they manipulate via their position.
I mean at the end of the day it's just all making an educated guess on what will happen in the future all things going as planned. It's all to get an idea of the possibilities. It may or may not pan out.
Hi guys, was wondering if one can 'build' a kind if 'acceptable' cap rate from scratch for a market where there are few commercial real estate transactions and mostly not reported so cap rates cannot be computed with respect to NOI? I'm trying to do so by taking a risk free rate and adding an illiquidity premium but I didn't find any 'smart' method to estimate the other(s) premium that can be added to construct the total cap rate. Any clue?
Hi there, any metrics I should use if I want to buy the property for my own use , i don’t want to pay rent rather pay my own place , any suggestions? Thanks
Strong video! Just a small side note, you mention that the cap rate does not incorporate a growth rate but technically it does. It incorporates the growth rate of the NOI. The way real estate is being valued with the direct capitalization (DC) method is simply a derivation of the dividend discount model (DDM). DDM = Div1 / (r - g) --> for dividend-paying stocks, where r is the discount rate and g is the growth rate of the dividends. DC = NOI1 / cap So the cap rate equals the discount rate of the property minus the expected growth rate of the NOI and thus is incorporated in the valuation.
Rens Verbeek I believe you are incorrect if you are referring to time mark 3:45. The growth referred to here is an increase in market rents, thus an increase in NOI. The equivalent would be a change in the DIV1 variable (dividend payments) of the DDM model. The cap rate is independent of this and does not take this growth into account. The same will be for growth in appreciation, which would be a change in the DDM or DC variables, especially in a market like NYC. You’re confusing the growth of variables.
@@ed1pk The cap rate most definitely accounts for income growth expectations (NOI). Cap rate ≈ (Rf + Rp) - g. Holding the yr1 NOI constant, the cap rate can be seen as a function of the price, and the price someone is willing to pay for an asset like real estate will depend on the growth of the cash flows.
cap rates matter alot if you go into debt to acquire property. our principal hates debt and buys all his properties for 100% cash. since the cap rate takes into account the cost of finance, to buy and to sell is lower than if you have no debt and only need to worry about the discount rate portion of the cap rate. the more in debt you go, the higher the cap rate.
How do you value a SNTL building year to year since most of the value is in the beginning of lease and as its getting closer to expiration you have the question of will they go into options or will it go dark? 1/4 bps per year?
Hey Ralph, a next buyer will value the property based on getting a new tenant in there, so probably not a need to bump up the exit cap rate that much. I'd make an assumption about the renewal probability, leasing commissions/TIs and downtime, and then model out your cash flows from there. You may want to check out my Retail course for more details on how to do this (link here: breakintocre.com/courses/). Hopefully that helps!
Really good question. No rule of thumb, but as I mention in the video, if your loan constant is higher than your cap rate, your cash-on-cash return will be lower with debt than without it. This is really dependent on the goal of the investor - some investors may be looking to make a quick exit in 2 years and cash-on-cash returns aren't important to them, while some plan to hold a deal for 7-10 years and cash flow is their main play. So I hate to answer "it depends", but it really depends on the investor goals. Thank you for your thoughtful questions!
WRONG, this video is 2 years old and no one bothered to correct this yet?! 10,000,000 ÷ $600,000 is NOT a 6 cap rate it is a 16.666 cap rate. It is a 6% return which is horrible which is reflected by the high cap rate. If I'm wrong correct me but this part confused me.
Hi. On number #4 you mentioned that the cap rate for that property may be deceiving because the property wasn’t a full capacity and was renting below market price. I previously thought that cap rate, via the NOI metric, takes into account all scheduled gross income. What am I missing here? Thanks
Lol don’t listen to the guy above me! Justin is correct. Schedule Gross Income (aka max Potential Rent if building was 100% occupied) - Vacancy Loss + Other Income - Total Operating Expense = NOI The point he was trying to make was that Cap Rate is only applicable to stabilized properties. For example, I have an apartment building worth $1m, that’s only 20% occupied (4/5 units are vacant). The one in-place tenant that I have makes up my entire annual NOI at, let’s say, $10k. Technically, my cap rate would be 1% (10k/1m = 1%). That is a very low Cap and suggests that the investment has little risk. Obviously that’s not the case and any investor would want to get the remaining 4 units leased up. So now let’s say all 5 were leased at 10k/unit making my NOI = 50k/yr. That increases my Cap Rate to 5%. Thats the Cap Rate you want to use to compare it to other apartment comps your the market to see how your deal measures up with the other sales that have taken place recently
Ha! Thanks for the feedback - the video is just saying that the IRR is a much more reliable way of valuing a property than a cap rate valuation. Hopefully that makes this make more sense!
You should. I posted a 4 series from a ccim a few months back on cap rates. Dont use at all on value add. What is important is youur business plan and how well you implement it.
![The Equity Multiple Explained For Real Estate Investors [What You Need To Know]](/img/n.gif)
I diss agree. The cap rate comes in useful to find the current value of the property. The cap rate shows the correlation between the aking price to NOI. Make sure the property is worth the asking price.
My favorite channel on commercial real estate.
Would recommend doing a video on modified IRR, as the standard IRR assumes the investor can reinvest all positive cashflows at the calculated IRR. Another alternative is to make sure you always consider your net money multiple or excess economic value add given some minimal acceptable return.
So many good insights in here.
Negative leverage finally clicked that if a loan constant is bigger than cap rate its a negative situation.
Also why low cap rates in hot markets are okay.
Thanks Justin!
Thanks for explaining the “unspoken” truths that many miss.
Happy to help!
@@BreakIntoCRE do you utilize cap rate when determining value for multi family non commercial property.
For single-family residential properties, people like to use "Monthly Rental Factors" so you could just use that with a multi-family a lot of the expenses are different from commercial and residential.
Dude WTF? Why am I just finding out your channel just now? You smoke everybody else
Haha I love this. Great to hear you're finding the videos helpful and thanks for watching!
@@BreakIntoCRE Keep it up... build more subscribers. Don't give up... Meet Kevin specializes in sensationalism, perhaps you can think of a new approach to bring more viewers. I agree that your videos are most informative that give substance rather than fluff.
You know what... He actually does! He is really good with explanation of core concepts without unecessary shenanigans. Love this channel
I learned more from you in 9 minutes, 18 seconds than I did from others in years. You are the MAN!!
Thought provoking video but dangerous to say "don't really matter". Video makes sense if debt is not being used but in practice it almost always is. For good or for worse, cap rates are the core tool for appraisers and bank valuations so they in and of themselves establish value for lending purposes, hence they in and of themselves affect sale price. IRR is for your own internal metrics for what type of return makes sense for you as the investor... they don't move market prices like CR. Ie. If you bought a property at a 5 cap and several years later that areas market trended down to a 4 cap, if nothing else changed with regard to your NOI the increase in asset value and profit on sale would be extraordinary (so long as the buyer was using debt which should be assumed). Conversely if you bought at a 4 cap and property area trended up to a 5 cap, your asset could be worth less unless your grew the NOI by a significant amount. The point is this is an apple to orange comparison...CR are so embedded in the lending valuation system they matter tremendously to the ultimate goal of increasing IRR.
Very valuable info. Thank you!
Just for transparency maybe you could do a video on the pitfalls of IRR and show how a series of cashflows can have multiple IRRs when the cashflows are non-conventional. Two or three lots of cash outflows as opposed to just the one at the beginning.
Good content though cheers
Great feedback - thanks!
Excellent video on cap rates. This is the stuff they don't teach you during the real estate courses. How can you know so much and be so young....
Cap rates should only be used to determine CURRENT market value of an income producing property. That’s it
Yeah, he doesn't know what he is talking about.
Answer:
To bypass the risk of prospective buyers increasing the price solely due to Walt Disney's fame and/or intended use of the Real Estate, he decided to purchase all of the Real Estate in and around Orlando, Florida using several private Land Trusts.Dec 2, 2019
Home Run. Great video, easy to follow and understand.
#2 is huge why cap rates fail. lease acquisition costs matter.
Could you please explain how you calculated the 6.01% loan constant from the 4.4% interest rate amortized over 30 years for someone who is just starting to wrap their head around these concepts? Also, how you derived the 5.98% cash on cash return from that?
Loan constant is calculated by taking the annual interest and principal payment and dividing by the loan amount. So it takes into account the principal portion of the payment as well and not just the interest on the loan which is 4.4%
Cash on Cash is going to be the NOI after debt service divided by the equity amount. In this case you get a CoC that is lower than the cap rate which means you have negative leverage.
Hope this helps
this is actually pretty ingenious
Very valid points. I’ll add 2 more: Deferred maintenance. There may be several hidden issues waiting to happen. If the seller isn’t talking about them, I just assume he’s never done them. And #2, net migration is important but so is shortage of and reliability of labor force. That’s true especially in a post pandemic world. The cost of repairs vary from buyer to buyer, depending on whether they have the capability in-house of doing the repairs or not. Now, my question is, in a post pandemic world, post great migration, how do you factor into your IRR appreciation; the scale seems to have shifted a bit towards emerging markets and a bit away from the big metro ones.
But how can u predict your future sale price ? Which is the most significant assumption in IRR calc.
Can you do a video on: It all boils down to information. Specifically, the kind that tells where to buy real estate real cheap, knowing beyond a certainty, that it's going up, up, up in value. Walt Disney bought the land for his future theme park through trusts, Gee, I wonder why?
Oh, also do a video on our honorable States People in congress buying large blocks of stack in companies in markets they manipulate via their position.
I mean at the end of the day it's just all making an educated guess on what will happen in the future all things going as planned. It's all to get an idea of the possibilities. It may or may not pan out.
Do you have a video analyzing live factors that'll be a potential low cap rate emerging to market?
I love these web sights .
Hi guys, was wondering if one can 'build' a kind if 'acceptable' cap rate from scratch for a market where there are few commercial real estate transactions and mostly not reported so cap rates cannot be computed with respect to NOI? I'm trying to do so by taking a risk free rate and adding an illiquidity premium but I didn't find any 'smart' method to estimate the other(s) premium that can be added to construct the total cap rate. Any clue?
IRR or NPV. NPV is better when IRR and NPV come into conflict on 2 mutually exclusive projects.
Hi there, any metrics I should use if I want to buy the property for my own use , i don’t want to pay rent rather pay my own place , any suggestions? Thanks
Strong video! Just a small side note, you mention that the cap rate does not incorporate a growth rate but technically it does. It incorporates the growth rate of the NOI. The way real estate is being valued with the direct capitalization (DC) method is simply a derivation of the dividend discount model (DDM).
DDM = Div1 / (r - g) --> for dividend-paying stocks, where r is the discount rate and g is the growth rate of the dividends.
DC = NOI1 / cap
So the cap rate equals the discount rate of the property minus the expected growth rate of the NOI and thus is incorporated in the valuation.
Rens Verbeek I believe you are incorrect if you are referring to time mark 3:45. The growth referred to here is an increase in market rents, thus an increase in NOI. The equivalent would be a change in the DIV1 variable (dividend payments) of the DDM model. The cap rate is independent of this and does not take this growth into account. The same will be for growth in appreciation, which would be a change in the DDM or DC variables, especially in a market like NYC. You’re confusing the growth of variables.
@@ed1pk The cap rate most definitely accounts for income growth expectations (NOI). Cap rate ≈ (Rf + Rp) - g. Holding the yr1 NOI constant, the cap rate can be seen as a function of the price, and the price someone is willing to pay for an asset like real estate will depend on the growth of the cash flows.
How would you place a true value on a vacant land
cap rates matter alot if you go into debt to acquire property. our principal hates debt and buys all his properties for 100% cash. since the cap rate takes into account the cost of finance, to buy and to sell is lower than if you have no debt and only need to worry about the discount rate portion of the cap rate. the more in debt you go, the higher the cap rate.
How do you value a SNTL building year to year since most of the value is in the beginning of lease and as its getting closer to expiration you have the question of will they go into options or will it go dark? 1/4 bps per year?
Hey Ralph, a next buyer will value the property based on getting a new tenant in there, so probably not a need to bump up the exit cap rate that much. I'd make an assumption about the renewal probability, leasing commissions/TIs and downtime, and then model out your cash flows from there. You may want to check out my Retail course for more details on how to do this (link here: breakintocre.com/courses/). Hopefully that helps!
can you please explain why a loan above a cost of 4,25% reduces de equity IRR of a 6% cap rate deal? thank you!!!
Is there a rule to in terms of how much bps there should be between year 1 cap rate vs. loan constant?
Really good question. No rule of thumb, but as I mention in the video, if your loan constant is higher than your cap rate, your cash-on-cash return will be lower with debt than without it. This is really dependent on the goal of the investor - some investors may be looking to make a quick exit in 2 years and cash-on-cash returns aren't important to them, while some plan to hold a deal for 7-10 years and cash flow is their main play. So I hate to answer "it depends", but it really depends on the investor goals. Thank you for your thoughtful questions!
Great video and explanation
Thanks for watching, Braden!
The points you make such as capital needs or rent projections affect any metric; not just cap rate. How is that profound?
Thanks! I'm confused.
Excellent Informative Videos... Thank you so much...
Thanks for watching!
how should we use Cap rates?
WRONG, this video is 2 years old and no one bothered to correct this yet?!
10,000,000 ÷ $600,000 is NOT a 6 cap rate it is a 16.666 cap rate. It is a 6% return which is horrible which is reflected by the high cap rate.
If I'm wrong correct me but this part confused me.
It's $600k/$10M = 6%. Hope this helps!
you're wrong. 600K/10M is a 6% cap rate
IRR starts @ 7:43
Excellent! Thank you.
Great video! Thanks for clearing up any misconceptions about cap rate
Very informative, exactly what I was looking for, thanks for the video.
@Andrew Cromartie thanks for your advice I will look into MIRR, I'm a noob so really didn't get into those details yet.
Hi. On number #4 you mentioned that the cap rate for that property may be deceiving because the property wasn’t a full capacity and was renting below market price. I previously thought that cap rate, via the NOI metric, takes into account all scheduled gross income. What am I missing here? Thanks
Occupancy does not change the cap rate. You are correct that he is misinforming you. Occupancy issues are dealt with by below the line adjustments.
Lol don’t listen to the guy above me! Justin is correct.
Schedule Gross Income (aka max Potential Rent if building was 100% occupied) - Vacancy Loss + Other Income - Total Operating Expense = NOI
The point he was trying to make was that Cap Rate is only applicable to stabilized properties. For example, I have an apartment building worth $1m, that’s only 20% occupied (4/5 units are vacant). The one in-place tenant that I have makes up my entire annual NOI at, let’s say, $10k. Technically, my cap rate would be 1% (10k/1m = 1%). That is a very low Cap and suggests that the investment has little risk. Obviously that’s not the case and any investor would want to get the remaining 4 units leased up. So now let’s say all 5 were leased at 10k/unit making my NOI = 50k/yr. That increases my Cap Rate to 5%. Thats the Cap Rate you want to use to compare it to other apartment comps your the market to see how your deal measures up with the other sales that have taken place recently
One of the best Cap Rate videos I've seen yet!
I like it. 💯
Internal rate of return??
th-cam.com/video/C2yO2I_SctI/w-d-xo.html
Doesn’t IRR calculations include subjective opinions of future property value growth?
Very helpful
Cap rates do incorporate growth.
"Anticipated" growth!
IRR!
That ad sucks
i dont trust this video....
Ha! Thanks for the feedback - the video is just saying that the IRR is a much more reliable way of valuing a property than a cap rate valuation. Hopefully that makes this make more sense!
Break Into CRE Ha!
You should. I posted a 4 series from a ccim a few months back on cap rates. Dont use at all on value add. What is important is youur business plan and how well you implement it.
@@royjohnsonfindingsolutions1429 very well said, Roy.
@@BreakIntoCRE and instead of irr use piir correct