All Forum Posts by: David Tipton
David Tipton has started 4 posts and replied 189 times.
Post: 4 Plex
- Los Angeles, CA
- Posts 197
- Votes 59
Originally posted by @Account Closed:
Originally posted by @David Tipton:
I really don't want to get involved in this hot mess of an argument, but it looks like I've been dragged in so I'll clarify my position. I'll start by saying I'm far from the smartest person on this forum. :)
I agree with @Account Closed and @Jacob Sampson on this one, but can see where @Account Closed is coming from. Before everyone kills me, let me explain.
Capitalization Rate = NOI/Value (or Purchase Price), everyone on here agrees on that. So @Ethan Bruland is correct when he reasons that increasing NOI will increase the Capitalization Rate for this property. It is the calculation of Capitalization Rate for that particular property, independent of the prevailing capitalization rates in the area. There is definitely a distinction between the two, as @Account Closed and @Jacob Sampson pointed out. I agree with the information in their posts.
However, I'll try to find a middle ground and give @Account Closed the benefit of the doubt. He seems to be coming from a practical place. It seems to me he thinks that the only metric that is worthwhile - once you already own the building, that is - is the prevailing capitalization rate in the community rather than on the individual property. There is some merit to that. Having the "Cap Rate" of a building you own go up doesn't mean that much to me, it's the Value that makes the difference. One can "work backwards" to get a reasonable value for a property by using the prevailing Capitalization Rate for an area. (However, as noted above, there is definitely a distinction between the Capitalization Rate of a property and the prevailing Capitalization Rate for a geographical region.)
Correct me if I'm wrong, but I feel like that may be what @Account Closed was trying to express? If not, you're on your own. :)
At any rate, I look at it like this:
If Capitalization Rate = Net Operating Income/ Value, it follows that:
Value = Net Operating Income/ Capitalization Rate
@Ethan Bruland, if you know that investors in your area will generally deploy capital (invest money) at a 7% Capitalization Rate, for example, you're $19,000.00 NOI would make the theoretical Value $271,428.57. If you increase the NOI to $20,000.00, you would increase the theoretical Value to $285,714.29. Etc. I would tend to think about it in those terms rather than increasing the Capitalization Rate of a building that I own. It makes more sense to me to think of it in terms of overall Value of the property. I hope that makes sense.
You can look through similar recently-sold properties and calculate the prevailing Capitalization Rates in your area to get an idea for what to plug in as your anticipated Capitalization Rate for the purposes of the formula above. Investors in your area may also know off the top of their heads what the general rates are, but I would err toward calculating myself. It will also help you to assess whether or not the building you are thinking of buying is valued appropriately. What you are looking for is essentially an average of the Cap Rates, trying to eliminate any obvious outliers. Good luck!
David, this is what you stated in another thread, "
because of the generally low cap rates, as small increases in rent have an exponential effect on value" That is what I was agreeing with. I'm a little confused about what exactly you are disagreeing with me.
Now I agree you can divide a NOI by any number you want. But of what use is it? Hell, I can divide the length of my , well you know what, by my height but again what does that number mean and of what use is it? What if I divided my current NOI by my 1978 purchase price?
Cap rates are born on the date of completed purchase. A cap rate will die on the date of a better cap rates birth.
Now you also stated above, "So @Ethan Bruland is correct when he reasons that increasing NOI will increase the Capitalization Rate for this property"
Let's do some math.
$100,000 NOI at 10% cap rate has value of $1,000,000.
$100,000 NOI at 11% cap rate has value of $909,090.
So how can it make sense for Ethan to increase his NOI, but since you said it would increase his cap rate, then he would DECREASE the value of the property?
Psst, my number is over 11%, not that it means anything.
I do not think what we are saying is inconsistent. It depends on which variable you choose to solve for in the equation.
1. Capitalization Rate = NOI/ Value (or Purchase Price)
In Ethan's example, he is solving for Capitalization Rate based upon his purchase price. His Capitalization Rate is higher because the purchase price does not change. He is not looking at the theoretical Value of the property for resale, but only at the Capitalization Rate. The Cap Rate is a metric of what percentage of his purchase price the property produces per year, without accounting for debt service. As NOI increases, the Capitalization Rate increases. It's one way among many for Ethan to know that he made a good investment. It does not affect the prevailing Capitalization Rate in the area, as that is tied to the time of purchase.
2. Value = NOI/ Capitalization Rate (estimated)
Now, if you are solving for the current Value of the property the equation is different. In that case, you use a Capitalization Rate you believe a buyer is willing to pay, judged by Capitalization Rates of similar, recently-sold properties in the area, at the time they were sold. When NOI increases, the Value of the property increases with it. That is a measure of the capital another investor in that area would be willing to deploy to get that same NOI.
The two calculations serve different purposes in different circumstances for different people. It sounds like you think Capitalization Rate is arbitrary. It is. It's just a random metric to be able to compare multiple, different properties on an apples-to-apples basis. It is one tool of many and it is not the end-all-be-all.
Post: newbie RE agent from Paso Robles, CA
- Los Angeles, CA
- Posts 197
- Votes 59
Welcome @Diana Gullo
Post: 4 Plex
- Los Angeles, CA
- Posts 197
- Votes 59
I really don't want to get involved in this hot mess of an argument, but it looks like I've been dragged in so I'll clarify my position. I'll start by saying I'm far from the smartest person on this forum. :)
I agree with @Account Closed, if you know that investors in your area will generally deploy capital (invest money) at a 7% Capitalization Rate, for example, you're $19,000.00 NOI would make the theoretical Value $271,428.57. If you increase the NOI to $20,000.00, you would increase the theoretical Value to $285,714.29. Etc. I would tend to think about it in those terms rather than increasing the Capitalization Rate of a building that I own. It makes more sense to me to think of it in terms of overall Value of the property. I hope that makes sense.
You can look through similar recently-sold properties and calculate the prevailing Capitalization Rates in your area to get an idea for what to plug in as your anticipated Capitalization Rate for the purposes of the formula above. Investors in your area may also know off the top of their heads what the general rates are, but I would err toward calculating myself. It will also help you to assess whether or not the building you are thinking of buying is valued appropriately. What you are looking for is essentially an average of the Cap Rates, trying to eliminate any obvious outliers. Good luck!
Post: Trying to get my First Multi Family in Southern California
- Los Angeles, CA
- Posts 197
- Votes 59
Hi @Karim Karawia, I agree with @Lee L. Its going to be hard to find a cash flowing property and it may be best to look for a place where you can "force" equity. LA is actually decent for that because of the generally low cap rates, as small increases in rent have an exponential effect on value. Only problem is navigating rent control. If you have the cash and cooperative tenants, you can exchange "cash for keys" and instantly build equity. If you have "bad" tenants, i.e. tenants that will not leave voluntarily, your investment may be a bad one.
Post: Hello this is stuart
- Los Angeles, CA
- Posts 197
- Votes 59
Welcome @Stuart Fox
Post: New member from Los Angeles, CA
- Los Angeles, CA
- Posts 197
- Votes 59
Welcome @Brandon L.
Post: New member from Anaheim, CA
- Los Angeles, CA
- Posts 197
- Votes 59
Welcome @Jonathan Rempel. Looking forward to reading your success stories.
Post: New member in the greater Los Angeles area!
- Los Angeles, CA
- Posts 197
- Votes 59
Welcome @Michael Payne.
Post: Starting Out in Los Angeles!
- Los Angeles, CA
- Posts 197
- Votes 59
Welcome @RD Delgado. 2016 is for making deals! Good luck!
@Dominique Hill I think it depends what you're selling.