Exhibit A Conclusion
What ’ s this About Risk ?
According to Investopedia “ a lower Cap Rate corresponds to a better valuation and a better prospect of returns with a lower level of risk . On the other hand , a higher value of Cap Rate implies relatively lower prospects of return on property investment , and hence a higher level of risk .”
So , here are some of the risks they mention : 1 ) Age , location , and status of the property 2 ) Tenants ’ solvency and regular receipt of rentals 3 ) Term and structure of tenant lease ( s ) 4 ) The overall market rate of the property and the factors affecting its valuation
5 ) Property type : multifamily , office , industrial , retail , or recreational
6 ) Macroeconomic fundamentals of the region as well as factors impacting tenants ’ businesses
As a practical example , suppose you have two indentical 20 yearold fourplexes . One is next to a small shopping center containing a convenience store , a nail parlor , a bar , and a “ strip club ”. The second one is next to a goodsize church with a medical clinic across the street . Which is likely to have the lower (“ better ”) Cap Rate ? So , that ’ s risk .
An Educational Example
Exhibit “ A ” is a listing of a vacant 78yearold , 2082 sq . ft . house on a city lot . The agents say it ’ s a singlefamily residence ( SFR ), but it can be turned into a Residential Care Facility as a “ value add ” opportunity . Maybe add an ADU since the lot size is apparently sufficient .
The computation shown here https :// realty411 . com / whataboutcaprate / shows a Cap Rate of 16.40 %! That ’ s amazing ! It ’ s not really a miracle . They PROJECTED the Residential Care Home on to the property . Here is the lesson : This is a PROJECTED Cap Rate . Who knows what will happen ? It is basically meaningless . Yogi was right .
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Cap Rate is one measure out of about ten that are useful for real estate investment analysis . It has value on larger projects like multiunits and other commercial properties , but on smaller residentials , say 120 units , it ’ s not necessary . Just compute the cash flow , and see if you like it .
Cap Rate has several formulas , which can be confusing and even contradictory . If you ’ ve decided to use it , select a formula that has meaning for you and apply it consistently to your investment decisionmaking .
Calculating investment metrics is “ desk work ”. Necessary , of course . But also needed is “ field work ”. Go investigate the property . Where are the bar and “ strip club ”? Or the church and medical center ? Remember , you can improve the property , but not the neighborhood .
And don ’ t put too much stock in anybody ’ s projections . The property needs to make sense today .
MEET BRUCE KELLOGG
Bruce Kellogg has been a Realtor ® and investor in California for 44 years . He purchased about 350 investment properties for himself , mostly with high leverage and taxdeferred exchanges . In the process , he made three fortunes , and experienced three real estate downturns since 1980 . He has transacted about 550 properties for clients , creating fortunes for several . His book , Real Estate Investing Wisdom , is in publication .