How Financing options affect your returns
One of the most frequent questions that we get asked is “what’s the cap rate” on a property. A lot of people have sticker shock and are surprised at the cap rates that properties are trading for in the current environment. Unless you’re paying all cash, there are other things to consider other than cap rates - namely the cost of capital and the spread between the two.
Our goal is to advise the people that we work with in the best possible way. In this month’s newsletter, we’re going to compare different paying cash with different loan options (bank/bridge loan, or using agency loan, with and without an Interest Only period) to see how they affect the year one cash on cash return.
Year One Band of Investment:
When you get financing, 65-75% of your return is determined by your financing. With the cost of capital at all time lows an investor can still yield the same return as they could in the past, even in an environment when cap rates are going down. The lower interest rates either benefit the seller because they can get higher pricing, or the buyer because they can get better returns. On this example for a property with a $500,000 NOI, an investor could pay $3,600,000 more for it using agency debt with interest only and still get the same year one equity return as they would if they would’ve paid all cash. This shows the power of positive leverage and the benefits of using financing to boost returns. It also shows why cap rates from years past are irrelevant to todays cap rates since the financing has changed so much. Using cap rates alone as a measuring stick may cause you to miss out on a lot of great opportunities.
Call us when you’re ready for a current market valuation of your property, and we’ll strategize with you on how to get top dollar for it.