What is a “cap rate”? In Part I and II of Techniques to Speed Up…
Browsing: Capitalization rate
Many investors want to enter into the world of commercial real estate without truly knowing…
This is my first post on The BiggerPockets Blog and I just want to state…
Many investors have a favorite strategy for weeding through the numerous income properties on the market in their search of a solid investment. Some use the “price-per-door” as a benchmark. Others consider the “gross rent multiplier (GRM)”. Yet others are convinced that capitalization (cap) rates are the way to go.
Which evaluation tool is best?
Investors have asked me the above question numerous times. A more profound question would be, “Is there really a BEST way? Let alone a right or wrong way?” Let’s explore some of the common comparison strategies.
This technique is extremely easy to apply. Simply take the building price and divide by the number of total square footage of improvements. Thus, a 12,000 square-foot property with a list price of $1 million has a price-per-square foot of $83.33/sq. ft. This can be a useful tool when comparing different properties in a demographic area. It is not, however, without its limitations. For example, this method does not take income or expenses into account. Evaluating a property exclusively with this method and you could find yourself money pit and you wouldn’t even know it.
Income properties are, to many, the ideal investment. Not only does one receive rental income on a monthly basis, but he also gets to enjoy capital appreciation—or at the very least, a solid hedge against inflation. With favorable tax treatment throughout and available 1031 tax deferred exchanges, one would be silly to not at least consider real estate investment.
And so he does. Hypothetical investor Bob purchases his first income property: an 8-unit multi-family in sunny San Diego, California. He loves the fact that it’s in a great location, has a favorable unit mix, and there has only been one vacancy in the last two years—and that vacancy didn’t last very long. As far as Bob is concerned, he has made the perfect investment. How could he do any better?
Raise the rents!
Typically, investment properties in low-vacancy, heavily renter-occupied housing areas that incur vacancies about as often as the Chicago Cubs win World Series have one problem: their rents are too low. If the rents weren’t below market, they would incur significantly more turnover.
That’s the key word: turnover
Turnover is a good thing; vacancies, themselves, are not. What’s the difference? A vacancy occurs when a unit has been turned (i.e. “rent ready”) and it does not have a tenant, or a prospective tenant. Turnover occurs when someone moves out of a unit and another moves in.