dimanche 11 juin 2017

Capitalization Rate

A friend of mine is looking at starting a business soon, like within the next year or so. I'm going to help him out as much as I can. Obviously, the biggest issue, is real estate. I've been educating myself, via Investopedia and other sources, regarding real estate and business investment.

According to Investopedia:



For example, if Stephan buys a property for $900,000 and expects that the property will generate $125,000 per year after operating costs, the capitalization rate for his investment is 13.89% ($125,000 / $900,000 = 0.1389 = 13.89%). What this means is that, every year, Stephan is earning 13.89% of the value of his property as profit.

This example assumes that all factors of Stephan’s cap rate calculations will remain constant, but in reality things often get a little more complicated. Suppose that due to a boom in demand for real estate in Stephan’s town after he makes the investment, the value of Stephan’s property rises to $2 million by the time two years has passed. Meanwhile, Stephan has been making the same amount of money from the property. Since capitalization rate calculations use the current market value, the capitalization rate of Stephan’s investment has changed. Because the market value of the property has risen while Stephan’s NOI has not, the cap rate has dropped considerably to a less favorable 6.25% ($125,000 / $2 million = 0.0625 = 6.25%).
My question, or issue, is this:

If Stephen already bought the property at $900,000, that doesn't change the profitability of the rent he's charging, just because the VALUE went up. He still paid only $900,000. The change in value of his property, does not change his initial investment. He's still earning 13.89% each year towards paying for his initial investment. Any income earned past 60 months, is profit (probably longer than that, due operating expenses such as repairs, employees, utilities, and management.)

This rate only seems useful to INCREASE profits, by raising rent on the residents. It sounds like an excuse to do so.

If anything, his asset value went up, rather than him somehow losing profits.

Any thoughts?

EDIT: It seems to only be useful to a buyer, in case Stephen in the example above, decides to sell on the market. If he decides to sell the property in the future, I can see him raising rent periodically, in order to make the property more attractive to any future buyer. I just don't see how it hurts his own investment if he stays with it forever, or upon retirement.

via International Skeptics Forum http://ift.tt/2sQPgYz

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