Are you planning on investing in an investment property in the Central Valley for the first time? If so, you may be wondering what a good capitalization rate is for real estate investments.
In this article we will provide you with tips on capitalization rates when investing in rental properties so you know exactly what to expect when you make your investment.
Understanding Capitalization Rates in Real Estate Investment
Benefits of Lower Cap Rates
For many years, I thoughts I was the smart one, buying in Ohio at 10 percent cap and thinking that all those people paying 5 percent cap were stupid. But the more I studied, the more I gained an appreciation for the fact that people buying at low cap rates have already made all the money they’ll ever be able to spend. They are willing to pay a premium for safety instead. And the reason they would go into a market and deploy at 5 percent cap is that they feel their money is safer there than somewhere else.
So, when I see BlackRock deploying a billion dollars at 5 percent cap in a market today, the only comment I have is, “How do I get in on that?”
Benefits of Higher Cap Rates
I am not specifically discussing value-add in this article, which is an integral component but lies outside the scope for today. That said, here’s some rationale.
Clearly, I cannot simply buy a value equivalent to 5 percent cap. Nothing cash flows at 5 percent cap, and I do need some cash flow in order to hold onto the asset long enough for it to do its thing. And unlike those other folks, I still need to create wealth. So, if I must buy at 5 percent cap because such is the market, what I can do is find an asset whereby having paid a price equivalent to 5 percent cap, I can then improve it to where my new income will represent a 7.5 percent cap upon my basis.
In this case two things happen:
I will cash flow well at 7.5 percent cap.
I will create a lot of value, because while the re-positioned NOI represents a 7.5 percent cap upon my basis, I am still in a market that trades at 5 percent cap rate. When I go to sell or refinance the asset, this delta of 2.5 percent cap represents millions of dollars of value. This value is what I am really after, since I want to create wealth.
So, in the end, I will have not just the cash flow but also wealth to go with it. Perhaps I should turn that around. In the end, I’ll have wealth and some cash flow to go with it. And I am much more likely to achieve this desired result in a low cap market.
Contact RPM Central Valley
To learn more about a good capitalization rate when investing in real estate, or to speak with us about our property management services, contact us today by calling (209) 572-2222 or connect with us online.