Cap Rates and Return on Investments

Guest blogger on Cap Rates and Return on Investments:

So I was sitting down doing some math last night trying to figure out what I am going to do with some money I am getting from the sale of our old office building. My plan is to do a 1031 exchange and buy an apartment building somewhere in California. So I started to look at the numbers and the key when you look at commercial building is the Capitalization Rate and of course the return on investment. I look at the same thing when I look at residential properties, but this is like buying 10 residential properties so I need to be careful. What I found was pretty amazing and I hope this doesn’t bore you! If you buy a $100,000.00 Commercial property at a 4.0% interest rate with a 5% Capitalization rate then your return on your investment is 8% assuming no appreciation. If you buy the same building with a 4.5% interest rate and a 4.5% Capitalization rate then you would have a 4.56% rate of return on your initial investment.

So looking at that I can still make a case for the 4.5% cap rate with the 4.5% interest rate because of the lack of inventory and the crazy rents that are going on at this time, but I like the first one much better. So to put this into terms of a single family residence which is where most investors start. Using my favorite 3+2 1128 square foot Sunrise Home that will rent for $2500-$2600 per month. This property will cost about $460,000.00 and your rate on a rental today is 4.625% with 25% down and you would have a 4.933% Cap rate and a 6.5% Return on your investment with $2500.00 in rents. If you rent for $2600 then your Cap rate goes to 5.19% and your return on investment jumps to 6.72%. As rents get more expensive your Cap Rate and ROI will increase and if property values increase by just 3% per year then your actual ROI will be closer to 18%! Yes a 3% increase in price is 12% gain on your initial investment and that is why Real Estate is so AWESOME!!!

If you hate numbers then skip this section!

Return on Investment (ROI) – Take the annual profits and divide by the amount of your investment. $100K Price 25% down = 25K // Profits are $1500.00 annually then you have a 6% Return on investment! Divide $1500 by $25,000 and you get .06 or 6%!

Capitalization rate (Cap Rate) – is the rate of return assuming a property is purchased for cash. So if you have a property where you pay $100,000.00 and after all expenses you receive $5000.00 per year then you have a Cap Rate of 5%. Cap rates are higher when interest rates go higher because there is not usu
ally enough cash out there for the lower capitalization rates.

Mike Meena
Augusta Financial
24018 Lyons Ave, Newhall CA 91321
Phone 661-260-2970 Fax 661-554-7121
Email – [email protected]
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