Capitalization Rates and Commercial Real Estate

Capitalization Rates and Commercial Real Estate

As an FHA MAP Lender, I often deal with a lot of first time buyers of commercial real estate and other people who are relatively new to the business. I appreciate the opportunity to work with such capitalists and enjoy sharing some of the things I have learned over the years. Even with experienced owners, making a lot of money, the purpose, definition and application of cap rates to commercial real estate are not entirely understood. Further, most people don’t know how to calculate a Cap Rate correctly anyway. So let’s talk Cap Rates. A Capitalization Rate is the rate of return one can expect based on a particular net operating income in relation to the purchase price or perceived value. Looking at it as an equation, one would get this: Cap Rate=NOI/Value Let’s take an example: Say you have a property with $100,000 in net operating income. “Net” in this example is rental income and ancillary income less vacancy, skips and after expenses for marketing, management, general administration, utilities, payroll and related, insurance, repairs and maintenance, taxes and reserves. In this example, if the purchase price is $900,000, the Cap Rate is right at 11%. If the purchase price is $1,100,000, the Cap Rate is right at 9%. At a cool Million, the Cap Rate is 10%. Think of it this way: If one buys at $900,000, and assuming no debt, how long will it take to get the purchase price repaid from the property’s operations? At 9 years, the rate of return is 11.11%, say 11%. At $1,100,000, it is 11 years, or 9.11%, or just a...

Falling FHA Multifamily Mortgage Rates?

Will Economic Indicators Affect FHA Multifamily Mortgage Rates? Today the Jobs report stated that 148,000 non-farms jobs were added in September when the consensus expectation was 185,000 jobs were to be added.  This gap has led the 10 year Treasury yields to drop from 2.60% to 2.52%, the lowest they have been since mid-July. So what does that mean for FHA Multifamily rates? As I said in an earlier blog post, two things are keeping rates high. First, there are a lot of REMICs that are still underwater, needing the high interest rates of new securities to leaven the entire REMIC so as to increase the weighted average coupon from earlier purchases.  This hangover continues. The security buyers are trying to hold investor coupons above 4% so as to be able to curtail losses on those underwater loans bought before the Bernanke pronouncements in May. Secondly, the investors in the securities have been expecting higher yields next year, based on tapering the purchases by the Fed. This made it likely that next summer’s rates would be much higher than today’s rates, causing investors to want the higher rates expected next year. Securities have been priced accordingly. With today’s Jobs report, and the weak data probably coming out over the next few weeks, it is likely that the Qualitative Easing will continue.  If rates stay low, the large spreads, especially in new construction under the 221 (d) 4, will have to narrow, bringing rates down. As an interested party, what should you be looking for as a sign of lowering rates?  If the 10 year Treasury bond continues/stabilizes in the 2.50%...