Capitalization Rates

There are a number of objective ways to value a rental or commercial building. One, the “capitalization rate” is determined by taking the net operating income (income after paying everything), and dividing it by a rate of return, say 7%. So, if you net $40k, the place should sell for about $575K. I ran this by a broker today and they looked at me like I was just making it up. I tried rent multiples. Bridgeport usually trades at 4 times gross rent, Greenwich as high as 12x gross. So, gross was $51,000, we were up to $610,000. Broker looked at me like I was just making this s*@! up. Finally I said we couldn’t pay the $995,000 they were asking for, and the broker said “we are not going to consider any lowball offers”. I ask how they got to their sale price, the answer was “he paid less for this in 2008″. Uh, duh. Its going to be a long 2012

17 Comments

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17 responses to “Capitalization Rates

  1. Dan

    Unfreakin’ believable. Totally indicative of the market in general – Just with this product type you have an objective way to tell them they’re crazy. Just going to have to keep renting until reality sets in. So frustrating for buyers. I can only imagine trying to make a living at it.

  2. anon

    and while you are contemplating capitalization rates, here’s a choice morsel from Politico:
    Left vs. White House over mortgage deal
    http://www.politico.com/news/stories/0911/64344.html
    “President Barack Obama’s liberal base says he’s on the verge of selling out to the banks again. This time, the problem is a subprime mortgage settlement that his administration is pressuring state attorneys general to sign off on — a deal that could stop many state investigations and prosecutions about mortgage lending practices…..”

    • Not a good deal. Credit to Schneiderman in New York for derailing a bad sellout to banks. Let them take the lumps for their mistakes, the same as the rest of us do

  3. Demmerkrat Patriot

    Too many Real Estate agents have been indoctrinated into the school of “Greenwich Real Estate Never Loses Value” …. In the current market, I imagine pixie dust is a big seller with this crowd, too.

    It’s not 2005 or even 2008 any more.

  4. John

    Obviously a Business School grad……

  5. Ron Paul Revolution

    The fed govt was complicit in forcing the banks to end redlining and they looked the other way when the banks used less than moral means to secure loans. Now one hand washes the other.

  6. Longing for Chris...

    Do tell….. Is the ugly-never-sold-so rented instead- house on Maple- ”new buiild” sideways onto the road- back on the market????

  7. George Crossman

    You are not quite right Fred. The cap rate is the percentage you chose to divide into the net operating income and it is not a number you pull out of your hat. Markets have different cap rates. They are determined by taking the sale price of a comparable property and dividing by the net operating income of that property. Then you average the cap rates for the comps.

    • Sure enough, but markets have caps, and we can debate them all day. But if you can’t at least acknowledge it to be a function of how to figure what a property is friggin worth, you’ll never make a deal as you debate how pretty the new kitchen is

  8. Peg

    My favorite line from sellers is: “But we NEED “$x” amount.”

    I always feel like responding, “Well, then let’s ask a million more than that!” I mean, if we’re going for “need” – why not add in a bit extra?

    So many just do not understand that you get what a buyer is willing to pay. Period. What you paid, how much you spent improving, how much you love it and how much you NEED is irrelevant to potential buyers.

    I shoulda gone to law school like my mom kept recommending……

  9. TraderVic

    To recap (no pun intended), are there any rental properties in town where an investor could buy the property and rent it out and break even (rental income minus costs of a low cost mortgage, real estate taxes and maintenance)?

    • Yes, but only after sellers get religion. We are putting a buyer into a nice short sale in Cos Cob where he is going to make a good 6-7% annually, sheltered by depreciation to an extent. It can be done,and when priced appropriately, flies off the shelf

  10. Anon

    Don’t you need to account for residual value (e.g. what you could sell the property for after you’ve been renting it for several years?). Maybe you did that and I missed it.

    • Why should anyone account for what something COULD be worth in a few years? It could burn down, they could build a trash plant next door, or you could have oil under the house. You can’t quantify guesswork. An investment is what it is.

  11. Stanwich

    I hate when idiot residential brokers dabble in investment properties. They have no idea how to value anything.

  12. Pete

    A capitalization rate is an overall rate and includes provision for return of investment as well as return on investment. The residual value is built in because it is simply a ratio between value and income based on market data. In a discounted cash flow analysis, the net income stream over a projected holding period is discounted to present value at a discount rate (not a capitalization rate). The reversion value at the end of the holding period is also discounted to present value at the discount rate. The sum of the present values of the income stream and the reversion is the indicated property value.
    If some brokers can’t understand a simple overall capitalization rate, I don’t think talking about other income approach techniques will help.