As a real estate investor, there is a lot to take into consideration when choosing an investment property. You want to get the most out of your investment, and therefore, both cap rates and interest rates are important to consider. Our team at Diversified Investment Strategies is here to fill you in on how these both affect you as a real estate investor, and to answer any questions you may have!
First, let’s look at cap rates. The capitalization rate is the rate of return on a real estate investment based on the income that the property is expected to generate. To determine the cap rate of a property, you divide the net income by the value. The net income is how much rent or revenue you receive from the property minus the operating expenses of the property, such as maintenance, repairs and taxes. The value of the property is determined by what it’s currently worth based on market conditions, or the price it’s selling for.
Investors typically seek properties with a high cap rate, because that means the income levels coming in are higher. However, higher cap rates may also mean higher risk for the investor. Plus, if a cap rate is low, there are still ways it could be increased, such as raising the rent.
When trying to decipher the cap rate for a property, take into consideration the location, asset type, and interest rates. It’s important to understand the relationship between cap rates and interest rates. Cap rates could shift unexpectedly for a property due to the change in interest rates.
Interest rates can vary from one commercial real estate property to another. Several variables affect an interest rate for commercial properties, such as location, lease terms and more. Both the financials of the tenant and the net worth of the investor play a role as well. Nothing is set in stone until an investor signs a commitment letter for a loan and a rate is locked in.
Cap rates and interest rates affect each other in that as interest rates rise, cap rates rise to compensate for the additional risk, because rising cap rates decrease a property’s value. Likewise, if interest rates decrease, cap rates decrease because the property’s value increases.
Our team at DIS can help inform you on the latest news in interest rates and the best rate options. We can also help you determine the cap rate of investment properties that you’re looking to purchase through a 1031 exchange. Cap rates and interest rates are just part of the puzzle when purchasing investment property, but they are important parts for an investor to understand and look into. Give us a call and let’s get started!