All Forum Posts by: Immanuel Sibero

@Pinaki M.

Cap rate is designed to be a valuation metric which has little to do with interest rate. However many investors insist on using cap rate as a performance metric (i.e. measure of income/return). As a performance metric, there certainly is a relationship between cap rate and interest rate since interest rate does affect performance of the investment.

Using cap rate as a performance metric, I think your understanding of the dynamics between cap rate, interest rate (i.e. cost of capital) and cash-on-cash is generally correct. As a matter of fact, you have just described the principles of leverage. What is not always true, however, is your statement - "as long as the interest rate of an mortgage is less than the cap rate of the investment, the investor is guaranteed to make positive cash flow..."

From the formula, we know that cap rate starts with NOI (i.e. revenues minus all operating expenses). To get to cash flow you would normally pay out loan interest, loan repayment, and capital expenditures. This notion of "guaranteed" positive cash flow is only good when you pay out loan interest only (i.e. cost of capital) beyond NOI. In this case, YES you will always cash flow because you take in 5.9% and you pay out 5.0%. As soon as you make additional payments beyond loan interest (i.e. loan repayment, capital expenditures) then there is no guarantee you will have positive cashflow.

So the quick rules of thumb for guaranteed positive cash flow are:

• cap rate is greater than interest rate (you've got this)
• the difference between cap rate and interest rate should be large enough to produce cashflow to cover loan repayment/amortization and capital expenditure plus some amount left over for the investor.
• if you're in a deal where you're financing with interest-only loan payment and there is no capital expenditures, then YES cap rate being higher than interest rate would very likely produce positive cash flow.

Cheers... Immanuel

Agree with @Nick B.

Cap rate is a "valuation" metric and is a component of the income approach to property valuation. It applies only to commercial properties because commercial properties are valued by their income. It does not apply to SFRs because SFRs are valued using sales of recently sold comparables.

Some investors insist on using Cap Rate as a "performance" metric to compare and contrast competing investment opportunities. As a performance metric Cap Rate is just flawed and there are other much better metrics (i.e. CoC, IRR). I would follow @Nick B. 's advice.

Difference between Cap Rate and CoC??

- Cap Rate is property specific metric, while CoC is investor  specific metric (i.e. regardless of whether or not financing is used).

- Cap Rate = CoC when Financing = 0

- If you don't finance a property CoC = Cap Rate. If you finance a property CoC is a better metric than Cap Rate. So why use Cap Rate at all then? Why not use CoC exclusively?

Cheers... Immanuel

@Brian Burke

Thanks for weighing in on cap rate confusion. Cap rate being defined as some measure of income/return, has been a standard definition on BP. Doesn't help much that investopedia.com defines cap rate as a "rate of return".

https://www.investopedia.com/terms/c/capitalizatio...

Because of this many newbies have no choice but to get stuck in the mindset that somehow "cap rate" is strictly a measure of return and nothing else. I'm a newbie in MF so I know of this confusion firsthand.

I have pointed this out a few times but your weighing in on it sure carries a whole heck of a lot more weight! :-)

Cheers... Immanuel

@Craig Curelop

Thanks, yes I understand about "property" cap rate. I'm a relative newbie so when I see cap rate I think of "market" cap rate (i.e. the only kind of "Cap Rate" I have learned so far). Just a note to myself that sometimes people mean "property" cap rate when they say cap rate. I hope you can see how it can be confusing to newbies like myself. To get out of this confusion, sometimes I tell myself that "property" cap rate is really the Yield (i.e. operating yield which is NOI/Purchase Price) of the property. All of a sudden, things start to add up better conceptually:

- The higher the yield, the better the property.

- Increase yield, increase the value (i.e. classic value-add)

- Increase yield, does not necessarily increase risk.

Thanks for your time, Cheers... Immanuel

@Craig Curelop

Do you agree with the guys saying that higher cap rate = higher risk? Once you increase the cap rate of your property, does it now carry more risks?

In my market, the cap rate is 7%. If I bought a property making $70,000 NOI, it would cost me $1,000,000. If in a year's time, I improve the property so that it makes $80,000 NOI, I would likely be able to sell for around $1,142,857 (NOI of 80,000 / Cap Rate of around 7%) giving me a profit of $142,857. This is the way I understand how the cool value-add strategy that you referred to in your initial post. Notice that the cap rate doesn't change much but NOI has increased. Can you give an example of how to realize profit using this same value-add strategy by increasing cap rate?

Cheers... Immanuel

@Craig Curelop

@Joshua Levine

Well I think the classic value add strategy is to buy a property and use your business acumen to increase the property value by increasing NOI, not increasing Cap Rate:

- Cap rate is market driven, investors can not control (i.e. increase/decrease) cap rate. Cap rate is a measure of how desirable the properties are in certain markets.

- Just within this thread, there are at least two posters saying "higher cap rate = higher risk". If you could control cap rate, why would you want to buy a property and use your business acumen to increase cap rate? Wouldn't that mean you would increase the risk? (Higher cap rate = higher risk, right?)

Cheers... Immanuel

@Bobby Porter

Similar to SFRs, valuation of MF apartments is also commonly based on comparable properties (i.e. recently sold similar apartments). The cap rate used to calculate the value of a particular apartment is derived from “comparable” cap rates of recently sold apartments.

This derived cap rate is therefore market driven and by definition can not be controlled by the owner/seller. The owner/seller can, however, control his property's NOI (i.e. by controlling any component of NOI such as revenues, operating expenses, etc.). So an owner can increase the value of his apartment by increasing NOI but NOT by increasing cap rate.

I’m not with LUI but I’m sure this is what LUI teaches.

Cheers... Immanuel

This whole emotional support animal thing is being abused excessively. I'm having trouble understanding how tying up a dog outside is supporting a person emotionally. Does one get emotionally satisfied by tying up a dog? 

@Allyssa McCleery

Cash on cash is definitely a metric that's commonly used and will not steer you wrong. As far as monthly or quarterly report goes, this would depend on your specific situation. I don't do any kind of scheduled reporting for my rental houses. When you have tenants sign a year's contract you know what you're getting every month, I'm not sure what monthly or quarterly reporting will tell me what I don't already know or at least have an idea about. There is just not much going on in a rental house to warrant such regular reporting. But again this is investor specific and may change as you scale up (i.e. when you get to 20, 30, or 50 rentals?)

...I think it is better to use the purchase price as well because the current value will not matter as much unless I am getting ready to refinance (I am) or sell.

Agreed. Current value does not matter for purposes of calculating cap rate (i.e. heck... cap rate does not matter much for residential properties anyway). When you purchase a property, the current value does become your purchase price which can then be used to calculate cap rate, if you so desire.

Good luck to you.

Cheers... Immanuel

@Brooks Johnson

In SFR type of property, cap rate = crap rate. It's a metric of how much "waste" you produce... :-)

Seriously, just use CoC or IRR or both instead.

Cheers... Immanuel