CAP rates are for Dummies - Posted by Chuck
Posted by Chuck on October 18, 2003 at 12:35:13:
I’ve yet to understand why people get excited about CAP rates (market value), NOI’s (pre-debt service and tax dollars), or GRM’s (potential gross income that doesn’t account for vacancies which could have an impact (duh) on the accuracy of the property value estimate), Appraisals, etc…
I could ramble on but I think you get my point (it’s all emotion or speculation), and none of these factors should be used as a buying guideline which ultimately determines how much “cash flow” you take home at the end of the month.
Look at it this way… would you (could you afford to) do lonnie-deals based on cap rates?
I think not.
Apples and Oranges you say… no… an investment is an investment, the only differance are the numbers and thus the risk involved.
So why are people investing (or rather borrowing) thousands and millions of dollars (along with interest), based on a CAP rate or a NOI which doesn’t include deductions for said debt service and it’s interest/rate? Don’t you think you deserve to earn more money on your investment (since your taking all the risk) than the lender will on the money they loaned you? Wouldn’t “yield” (aka IRR) be a better measure of a properties earning potential (vs risk and cost to aquire) and thus it’s investment value?
And as if those questions were not enough to make you stop and re-think things… let me pose one more… what did we use before the CAP rate concept was invented as a method of valuation and why did we change?
Two Big Mac’s to anyone who knows the answer.