What is Cap Rate? April 10, 2009
Posted by janey in : commercial finance , comments closedA very important concept in the commercial real estate industry is capitalization rate, or cap rate, of your subject. This is a way you can compare one income producing commercial property to other similar properties. It is also a way that allows a commercial lender or buyer of a property to value a property based on its income.
Being able to calculate capitalization rate of a building gives you one more way in which to value a particular property. By being able to calculate this figure, someone looking to purchase a property has a tool with which to ballpark value of a property. It also allows a bank making commercial loans to make sure the value of a property and subsequent loan to value fits their guidelines without investing too much time. This calculation does not take the place a full appraisal, but is a good time saving tool to use to find a quick estimate of value. Using the cap rate values a property based on the income, rather than sales comps, and the values returned could be different than what an appraisal may suggest.
Cap rate simply put is the estimated return for one year if a commercial property was bought cash (no loan). The cap rate is taken by dividing the net operating income by the estimated fair market value of the property. The higher the cap rate, the better buy a property may be.
When you do these calculations, it is very important to be working with accurate numbers. Your end result is only as good and accurate as the input. A small difference in your cap rate can turn into large valuation differences. Much larger than you may think. The best way to explain this is to look at some actual numbers.
For our first example, we are going to look at a property that has a net operating income of $200,000. If our property value were $2,500,000, then the cap rate of our property would be 8%. Our calculation would look like this:
Cap rate = 200,000/2,500,000
Cap rate = 8%
The formula for this is:
Cap rate = NOI/FMV, where NOI is net operating income and FMV is fair market value.
Another way to utilize cap rate is in estimating the value of a particular property. For commercial loans, this is a quick way to ballpark value on a particular transaction. We use the same formula, but instead of calculating for cap rate, we will figure for value. By contacting local realtors, let’s say we find out that properties in the area of the same type are selling for an average cap rate of 10%. Using $400,000 as the net operating income, we can work backwards to find a ballpark value for our property:
400,000/10% = 400,000/.10 = $4,000,000
So our implied value on this property using a 10 cap rate is $4,000,000. If you play around with the numbers and figure the value using an 8 cap, you will see that a 2% cap rate difference equates to a million dollar difference in value!
The formula we used for this example is the same as in our first, we just calculated for value instead of cap rate. The formula for this calculation is:
FMV = NOI/Cap rate
Hopefully this clarifies cap rate and how to calculate it not only for commercial loans, but also for evaluating your commercial real estate purchase. It is not a difficult formula, and once you are clear on how it works, it can be a powerful tool!
Get Paid On Time Every Time - Take Control With A Commercial Debt Collection & Prevention System June 3, 2008
Posted by janey in : commercial finance , comments closedThe harshest hazard for Growing Business Entrepeneurs in the UK isn’t lack of Customers, it’s Negative Cash-Flow.
It’s all too easy for the Growing Business Entrepeneurs to drop into the practice of first of all not seeing when Customers start to stretch their Payment Terms. There are three problems with this; firstly, financing the really does cost money, secondly, it increases your risk of losing the money all together, and thirdly it gives you the reputation of being a soft touch.
When cash gets problematic for your customers, they will prioritise their payments in order to survive with the minimum disruption to the business. If you’re recognised as a soft touch, you’ll unavoidably fall to the bottom of the Payment List. If you’re recognised to be on the ball and run a tight ship, you’ll inevitably [spin]climb|jump|float|rise[/spin to the top of the Payment List
That’s why it’s absolutely vital for EVERY business to have a good System in place from day one for Credit Control, Overdue Invoice Chasing, and Debt Collection Process.
Here are some good habits
Make sure you have a good set of Terms and Conditions, which setout your Payment Terms, When Ownership of the Goods is transferred and When Risk in the goods is transferred. Of course there are many other items to consider depending on what it is you’re selling. An excellent starting point is to study several of your competitors’ Terms & Conditions, then get a Lawyer specialising in Commercial Law to draw up a form of Terms & Conditions that suits you.
Have your Terms and Conditions printed on the back of your Invoice Forms, get new Credit Customers to state that they accept them before they take any goods, and publish the Terms on your website.
Always have orders confirmed in writing, and use a Courier that gives you a signed receipt for the Goods.
These first three steps assure you the best chance to enforce your invoices before the courts. The fact that your Debtor knows this makes it unlikely that he’ll push his luck, especially when you demonstrate that you also have a well structured Debt Collection Process.
Think about whether you need to sell on credit at all. If your average invoice is quite small, offer Credit & Debit Card Payment Facilities instead of Credit Accounts. After all, these days, if someone can’t get a credit card, should YOU be granting them credit?
Review all overdue invoices on a weekly basis, and have a system of standard letters which start chasing the money within 7 days of an account falling overdue. Most Book-Keeping Programmes will provide these reports Automatically.
Your Free Sample Debt Collection Letter needs to be part of a system, and it’s vital that the Debtor should know that they are in a Debt Collection Process which is trundling unstoppably and at a rapid pace to a conclusion, and that it’s costing them more with every day that passes.
This ensures that, even when the Debtor is struggling, you are the number one priority on the Debtor’s Payment List. It minimises the chance of Slow Payment becoming a Bad Debt Collection Situation.
I use a Debt Collection Process System called Get Paid Not Pain. It trains and incentivises your Customers to pay on time every time, and it has all the tools for stopping Slow Payment and Collecting Bad Debt.
