Hello Everyone,Math is not my strongest subject. I am having the hardest time with the CAP rate. For example, Frank commented on a discussion asking the value of the park. At at 10% CAP, the park was worth 78K. He stated that the person would want to look to get into it at a 12% or 14% CAP which brought the value down to 50K. This is where I am confused. Maybe I don’t really understand how the CAP is brought to life. I get the formula for the CAP but not sure how it all works together. And when you need to change that CAP, that confuses me even more. Can someone give me the CAP rate for dummies version or put it into a simplistic form for me? It probably is already simple, but math is again, not my friend.Thank you :-S Danielle
A CAP rate is nothing more than a fraction. The top part of the fraction is the net income or EBITDA. The bottom part of the fraction is the total price of the mobile home park, including any immediate capital improvements. So a park that has $50,000 of net income, and that you buy for $500,000 would look like this: $50,000 $500,000 = 10% CAP rateIf you alter the bottom part of the fraction to represent a $400,000 price, then just change that $500,000 to $400,000 on the fraction and you would end up with a 12.5% CAP rate. You can do the same on the net income, if that changes. Remember that all you have to do is divide the top part of the fraction by the bottom part to get the CAP rate.
@dmaxwellBest way to think of cap rate is as your rate of return on a real estate investment. In your example Frank paying less for Property A would therefore mean a greater/quicker return assuming the income remained the same. Of course with higher cap rates (or rate of return) generally comes higher risk like any other investment.There are a million other ways to explain the process but that’s it in it’s simplest explanation.
Thank you both for your responses. I think I may have been over thinking the whole concept.John - Why is their a higher risk if you are going to see your return quicker i.e. higher cap?Danielle
@dmaxwellNo investment returns are written in stone so the higher the perceived risk the higher the potential return. For example you can find small rundown MHP’s in the ghetto for 15-20 caps here in Arizona but a big four star park in Scottsdale would be a 5 cap. Sounds great…make your money back in 7 years vs 20. Well not so fast. The Scottsdale park would be a much"safer" investment. There’s volume in that park, clientele has money, and it’s located in a good area so your NOI would almost never fluctuate in fact would probably rise. The small ghetto park you’re dealing with low-income clientele and bad surroundings and infrastructure. Say a few people get evicted (inevitable in bad areas) and it takes a long time to fill the spots and all of a sudden your septic bursts. Guess what - your projected NOI and that year’s return is cut in half overnight. That’s not to say one investment is better than the other. There are countless people that have made millions of dollars buying distressed properties of all shapes and sizes just like there there are millions that have been lost with them. Just like so many have made millions leasing back beautiful buildings with miniscule cap rates to the Walmart’s and Amazon’s of the world while those same people are freaking out over the future of companies such as Best Buy right now. I’ll private message you my number and feel free to call me tomorrow since it’s hard typing out all this info. Getting into investment brokerage so I need to get used to explaining all this fun stuff.
Danielle -Remember to include in the bottom part of the CAP rate fraction any immediate improvements. For instance, in Frank’s example above if you purchased the park for $500,000, but immediately had to replace sewer lines and repave roads for $100,000, then your CAP rate is:$50,000 / ($500,000 + $100,000) = 8.3%That would be a less-good deal, than if you did not have to make the immediate improvements and could just purchase the property at a 10% CAP and not have to make any improvements. Think of CAP rate as the yield on your money. For instance, most banks right now are paying 1% on deposits; that’s like a 1% CAP rate. Obviously MHP investing is not guaranteed like leaving your money in a bank, but if you do your due diligence and education right, then you’ll do much better for yourself in real estate.My 2 cents worth,-jl-
Thank you all so much for the responses. That really helped.John- I couldn’t have asked for a better explanation. That made complete sense, so thank you for putting it into an explanation of a real scenario.Thanks again guys!Danielle