To position their business to meet the needs of a wide array of clients, real estate agents have to wear many hats and may even need to speak multiple languages, even financial-ese.
It is important for agents to know the difference between a baseball cap and a CAP rate, which is a capitalization rate, used to measure investment properties.
According to Grant Cardone, a sales expert and contributor to Entrepreneur, one piece of data doesn’t substantiate a deal.
“CAP rate is important but don’t get locked into focusing just on one term,” he wrote recently. “All the pieces of data matter.”
Since the CAP rate is the most common metric used to measure real estate investments, the next question your clients are likely to ask is what is a good CAP rate for an investment property?
As an agent, you should remember that a property’s cap rate is its annual net operating income divided by purchase price. This represents the unlevered annual return on the asset. Because one of the driving factors is income, often times CAP rates are projected based on an estimate of future income.
As an example, if a potential investment property for a client costs $1 million and has a net operating income of $75,000 annually, it has a 7.5 percent CAP rate.
As an agent, when you are analyzing a potential investment property for a client to determine the right CAP rate, you will want to look at several core factors, including location, asset type, and the prevailing interest rate environment. Each of these can have an impact on the cap rate of a property.
As it is, the CAP rate is a comparative metric. For your clients, it will be most valuable when it is to compare against very similar subject properties with a similar location, of the same asset type, and which are valued at the same point in time.
As an agent, you want to provide a solid CAP rate and it is going to be entirely dependent upon this context.
Cardone notes that there is another number more important than the CAP rate: 1.25
“That’s the Debt Coverage Ratio you want,” he wrote. “Look at this before you look at the CAP rate. You want the NOI bigger than the debt—a minimum 25 percent more income than debt. I prefer 1.50 for properties I take on.”
For your clients looking to invest, they will be more successful if they ask the hard questions and ensure they’re being adequately compensated for the risk they’re taking on. You will reap the benefits by having the answers to these questions.
