To summarize : high cap rates are great , but they can also point towards factors that increase the risk of an investment . A property with an 18 % cap rate might need work , and might not be in a highly desirable area . Ask yourself , “ Is this amazingly high cap rate stemming from high NOI , or low property value ?”
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What Drives Cap Rate Lower ?
Let ’ s consider what factors might contribute to driving a cap rate lower . If NOI decreases , our cap rate will decrease as well . We also see lower cap rates in the case of property appreciation — and appreciation is a very good thing .
If a property appreciates significantly , but revenue trails this appreciation , the property ’ s cap rate will go down . Lower cap rates can indicate highvalue properties , suitable for investors seeking lower risk . Generally , better neighborhoods trade at lower cap rates .
High vs Low Capitalization Rates
High cap rates are driven by two things — higher NOI , and lower property value . If a building needs renovation , this could result in a lower property value and , therefore , a high cap rate . With large amounts of maintenance needed to bring a building up to date , that high cap rate might mislead the investor and leave him with far more work and expense than he bargained for . But , if an investor is interested in updating a property , these high cap properties can potentially provide large rewards .
These property types are best left to investors who have experience , or who have a trusted guide that can help them find the right properties that balance their investment goals with their risk tolerance .
Figure Out What You Need to Know
If you know any two of the three variables of the capitalization rate formula , you can figure out the whichever variable you ’ re missing . This can be useful in a range of situations . For example , suppose you are trying to determine what you should offer on a property . If you know the property ’ s NOI and have a cap rate goal you want to target , then you can calculate what purchase price will give you the result you ’ re looking for .
For example , suppose your target is 8 %, and you ’ re looking at a property that generates $ 100,000 in NOI :
8 % = $ 100,000 / Purchase Price
Purchase Price = $ 100,000 /. 08
Purchase Price = $ 1,250,000
Or , if you have $ 500,000 to spend on an investment property , and are targeting a 7 % cap rate , you can figure out what level of NOI is required for you to meet your goals :
7 % = NOI /$ 500,000
NOI = 7 % * $ 500,000
NOI = $ 35,000
ReCap
There ’ s no set range for which are “ good cap rates ” — they ’ re most useful as a comparative tool between a few potential purchase opportunities that are similar in terms of location and kind .
High cap rate properties can be lucrative , but also come with an increased level of risk . If you ’ re new to highcap real estate investing , it ’ s best to partner with someone who has the experience and knowhow to get a deal done right . At TFS Properties , we specialize in pairing investors with properties that match their investment profile and risk comfortlevel while guiding them through the journey of building a secure investment portfolio .
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