I am frequently asked about capitalization rates (Cap Rates). The questions range from what is a Cap Rate, how is it determined, and which direction the cap rate is moving.
1. What is Cap Rate?
This is the rate of return that a reasonable investor would expect to receive as a result of their investment
.2. What Cap Rate do you utilize when valuing a property?
Each property and market is unique. There is no blanket cap rate used in our underwriting.
3. How is cap rate utilized?
The cap rate is utilized in underwriting to determine the value of the property based on the income approach.
4. What is the formula to calculate value based on the income approach?
One method to determine the value of the property is to take the net operating income/cap rate.
Cap rates are rapidly changing in today’s market. Various factors go into determining the cap rate (vacancy, market conditions, expectations on future inflation and interest rates, property condition, property location, etc…). The value of the property moves in inverse to the cap rate; the higher the cap rate, the lower the value and vice versa. In today’s market, I have been seeing cap rates rising by a couple hundred basis points. For example a small retail center 12 months ago might have been trading on a 7 cap; that same property today is likely trading closer to a 9 cap. As a result the value of the property has declined and lenders will likely lend less on the property today due to its decrease in value. More information on cap rates can be found at https://www.fairviewlending.com/underwriting.htm#4 or on our resources page https://www.fairviewlending.com/resources.htm .Contact us at info(at)fairviewlending.com if you have questions about small balance commercial lending, hard money lending, or private commercial lending. Fairview is the expert in all of these areas.
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