Understanding Cap Rates

Every now and then I receive an email from a subscriber asking me to explain "cap rates."

When you are considering real estate for an investment, you take the emotion out of the equation and look at your acquisition from a business perspective. The return on the investment is more important than how the property looks or its location. An important point to consider is the Capitalization Rate, often referred to as the cap rate.

The cap is calculated by dividing the property's annual net operating income (NOI) by its fair-market value. The NOI is determined by taking the effective gross income, and subtracting operating expenses. For example, you purchase a property for $250,000 that rents for a total of $2,000 a month with $20 additional monthly income and $667 in monthly expenses (that's $8,004 annually). Your cap rate is 6.0 percent (which actually would be a marginal return here in the Midwest, but this is just an example).

All things being equal, the higher the capitalization rate, the better the investment!

I Shouldn't Discuss Industry News When I'm on Holiday!

Am in New England on some business and some personal downtime this week, and heard the most horrid "subprime mortgage" story. A friend in southern Maine tells me that an acquaintance of his, with mediocre credit, was denied an $80,000 mortgage for a home on 2 acres in the woods "because a single woman with two kids shouldn't be living alone in the woods." Now, that is not grounds to deny a mortgage. But what makes it worse is that she supposedly was approved for a $130,000 mortgage for a house in town that she was concerned was more than she could support.

Guess what? Now she's in a bind financially and may lose the house. And the mortgage broker who found her the great deal and had a colleague find her the bigger home in town she really didn't want, has his fee and will feel none of the problems she is experiencing.

I deal a lot with incredibly honest, caring and smart mortgage people in the commercial/investment world. From big projects to small ones. It irks me to no end what has happened to people and their homes today. Some of it is "keeping up with the Jones" and overextending on credit, or taking that "interest-only" loan now because they figure they'll be doing even better financially in three years. But more and more it is being shown that a few uncrupulous mortgage brokers put people into homes the broker knew they would never be able to keep. At outrageous fees, at outrageous terms. And our economy is paying the price . . .

Okay, time to take a walk. Headed up a logging road for a long hike today. Maybe that will help me cool off!

Mailing Gets Under My Skin . . .

I can't believe what I got in the mail yesterday!!! A solicitation, via the National Association of Realtors, to buy life insurance annuities. This drives me nuts, especially since I can do better with real estate investments than I can with most stocks, bonds, annuities, etc.

Its funny, I bump heads occasionally with my "colleagues" at Prudential Financial, who sell insurance products for wealthbuilding. And we compare notes, and they tell me they don't want me anywhere near their clients. Because mine is a better argument.

Anyway, I have GOT to find out who to call at the NAR about this solicitation! Why in the HECK are they pushing insurance vehicles instead of the product in which we all specialize???? Sheesh!!

Fed's Bernanke Finally Chimes In On Subprime Mess

Rising delinquencies and foreclosures, said Federal Reserve Chairman Ben Bernanke in remarks yesterday, "are creating personal, economic, and social distress for many homeowners and communities -- problems that likely will get worse before they get better."

Thank you Mr. Bernanke for echoing what I have been telling clients for more than three months now. I'm glad for the validation.

Ownership vs. Securities Investments

Reason Number 89,652 (okay I'm exaggerating a little, but I wanted to get your attention) to own your OWN investment real estate, and avoid unregulated risk in the market . . .

THIS AFTERNOON Bear Stearns told investors in a letter that two hedge funds that invested in securities backed by subprime mortgages have very little or no value. The news, coupled with last week's decisions by ratings agencies to downgrade their ratings on billions of securities backed by subprime loans, could force other securities firms to write down the value of such investments.

Look At The Green Grow!

A new McGraw-Hill Construction report states that 2009 will be a tipping point for green building. The report predicts that within two years sustainable buildings will comprise 16 percent of large corporations' real estate portfolios. Why? Because energy costs are the largest controllable expense in office buildings.

McGraw-Hill cites the following payback on green commercial real estate: 8-9 percent decrease in operating costs; 7.5 percent increase in building value; 6.6 percent ROI improvement; 3.5 percent occupancy increase; and 3 percent rent increase.

Fridays Keep The Business Interesting

You never know what will happen when you're in the office on a Friday afternoon.

I recently completed a lease project with a major Atlanta exhibition company that was looking for retail space in Central Ohio. High profile exhibition that the entire community is talking about. I'm now looking for space for this same company in another Midwest market. I would not have had the opportunity had I not been in the office on a Friday afternoon. Ironically, they needed an architect. I called a few I knew and who were referred, and the gentlemen who did a fantastic job for this client answered his phone . . . when? . . . on a Friday afternoon.

Along the same lines, I've got a West Coast company coming into Central Ohio and we have found a couple possible spaces for them to lease. I'm also on a task force of Prudential CRES agents representing a California-based IT client that is developing the nation's most secure online data center -- inside a mountain in eastern Kentucky. We are the leasing agents for the Tier 4+ facility that will ultimately be 10 times the size of the NORAD complex in Colorado's Cheyenne Mountain.

Its why I love this business. I get to work with so many different people and companies. And once more I'm sitting here rambling while waiting for a case in the jury pool at Franklin County Municipal Court.