@Brent Coombs Let's look at an example. You are buying a property for $100k and it has an NOI = $10k (rents minus expenses excluding Debt Service). The Cap Rate is = NOI / Purchase Price (PP) = $10k / $100k = 10%. Let's say that's inline with the Market Cap Rate.
Now, you but the property and then you go to the County and fight and win a reduction of your Property Tax by $1k. Your NOI increases by the same amount of the Property Tax reduction now = $11k.
We now have to look at the valuation of the property you bought by calculating the Selling Price in relationship to the Market Cap Rate.
To Sell the Property at 10% Cap, PP = NOI / Cap Rate. So the new PP = $11k / 10% = $110k. Effectively, you increased the value of your property by $10k if you lowered your Property Tax by $1k.
I also wanted to expand on the Concept of Moving Cap Rates.
Depending on certain factors, the Cap Rate for Cities and Neighborhoods in Cities will move.
A typical example is when crime increases in a neighborhood.
If Crime increases over an extended period of time, years for example, investors will demand a lower price for the investment given the same NOI. Thus increasing the Cap Rate to compensate for the higher risk.
Similarly, if a neighborhood improves, the price of the property rises even if the NOI does not increase very much. This can be due to the perceived desirability from people just wanting to live in the neighborhood. This effect happens a lot during a period of Gentrification in Metropolitan areas.
What I tend to do is to buy in area where the Cap Rates have a distinct downward trend. Before of the above formula, PP=NOI / Cap Rate..... keeping the same numbers.... let's say that the Cap Rate for a neighborhood is currently at 10%. However, because Gentrification, we know from history of other neighborhoods that the Cap Rate is most likely to fall, and probably to 5% as other comparable neighborhoods are at 5%.
We can then do a Future calculation to determine the amount of Appreciation of the Investment.
For a property that you are buying at $100k with a Cap Rate at 10%, we know that IF the Market Cap Rate falls to 5% and NOI stays the same at $10k.... we will get the following Calculations.... Current calculations is PP = $10k/10% = $100k. When the Cap Rate falls to 5%.... the new calculations will be PP = $10k / 5% = $200k.
While all of this is fairly obvious, I think Investors need to do these calculations to get an intuitive feeling on how their Investment's future value may be affected.
You really want to invest in neighborhoods where the Cap Rate is MOVING DOWNWARD and NOT UPWARD.
If you have a good understanding of the surrounding neighborhoods and their cap rates and understand the history of those neighborhoods and their cap rates.... you can almost "feel" the Cap Rate as it moves along the wave.
Yes, it's probably way too much information! I realize that.... but after all these years as an investor who watches these things, I really get a clear sense of where to invest (or where to stay away from) and what neighborhood to target based on the wave of the Cap Rate movements.
Hopefully this helps in some way to the reader of this post!
Investor Llew
