Over the ages people have bought and sold businesses 
and investments – it is part of the joy and privilege of living in a free society.
CLICK TO SEE FULL ORIGINAL BLOG POST!
Whether you’re considering buying a lemonade stand, a major corporation like Coca Cola or American Express, or a basic Las Vegas real estate rental home, understanding CAP RATES is critically important.
(Make sure to watch the incredible video embedded at the end of this BLOG about a boy and his lemonade stand).
When someone buys real estate as an investment they are looking for two types of a return: (i) cash flow from the net income of that property, and/or (ii) a rise in the equity value of the property. It’s up to the investor, but the latter should be a secondary consideration when investing in rental property.
(My next BLOG post will discuss investments in equity-producing real estate investments – look for it in a few days >>> “SPECULATORS v MANUFACTURERS”).
A capitalization rate is very simple – it is merely the ratio between the net operating income and the capital cost of buying it (or its current market value).
Let’s look at a successful lemonade stand:
- monthly income = $1,000
- monthly costs of materials, labor, etc. = $800
- net monthly income = $200 (therefore the annual income = $2,400)
So then what is the value of this business? That depends on what cap rate is applied to it. Prevailing cap rates are usually somewhat relevant to the probable investment returns available in other investments. If someone can buy the lemonade stand and make a 5% return, then the value of the business is approximated by that expected rate of return. When sophisticated investors buy income streams of large companies, this same principle is applied – despite being in a much more complex environment.
Here are a few example:
- at a 5% expected return, the income stream of $2,400 is worth $48,000 (2400/.05)
- at a 6% expected return, the income stream of $2,400 is worth $40,000
- at a 7% expected return, the income stream of $2,400 is worth $34,285
Bear in mind that the cap rate does not establish the value of the business – it allows comparison to other investments by applying expected rates of return, and valuations remain subjective and subject to negotiation. As you can see, even a one percent change in the expected return can have enormous impact on the value of a business. And accordingly, it concerns me when I hear some agents in the Las Vegas real estate markets throw around investment return numbers.
In my professional opinion right now, an investor should reasonably expect about a 6.5% to 7.5% cap rate or RETURN ON INVESTMENT when buying a Las Vegas real estate rental income property – but my opinion is irrelevant, since investors must establish their own criterion. And interestingly, while the capital cost of buying a home in Las Vegas has risen nearly 30% in the last 15 to 18 months, rental rates have not – therefore, ROIs and CAP RATE expectations will begin to lessen accordingly.
When considering buying a Las Vegas real estate investment property, talk to a seasoned and rational pro – talk to Rob Flitton, “The Closer.”
Comments(0)