Talk:Capitalization rate/Archives/2012

Notes

Seems like there is contradictory information on the page.

Under the "Change in asset value" section, the article reads:

..."To get the rate of return on an investment, also known as an internal rate of return, the real estate investor adds (or subtracts) the price change percentage from the cap rate."

In the next section, "Relationship to similar terms", the article reads:

"A capitalization rate, or cap rate, does not equal the rate of return on an investment in real estate."

Can someone please clarify this.

Thanks,

````FK

FK - You should disregard that comment (the first one which states that the investor should add/subtract the price change percentage to/from the cap rate to determine an IRR. It is glib and inaccurate. There is much more to consider when determining the IRR of a real estate investment. Growth of rents, amount of capital expenditures, cap rate compression/expansion over the life of the investment, transaction fees, etc. —Preceding unsigned comment added by 195.229.241.175 (talk) 07:56, 3 February 2011 (UTC)

Cap Rate: Cash basis or income basis?

I am looking at a real estate valuation report supplied by CBRE, and they make no distinction whether cap rate should be cash or net income.

I think one reason people are confused, is that in U.S. tax systems, much of the income tax is paid by cash flow terms not net income terms. I.E. If you receive non-refundable deposit, the entire deposit is recognized as current period income for tax, although it will be recognized over the lease term on books.

Jun —Preceding unsigned comment added by 124.39.77.114 (talk) 01:55, 11 December 2007 (UTC)

A number divided by zero is not infinity. It can be termed undefined or indeterminate. Infinity actually has a value. —Preceding unsigned comment added by 167.7.90.235 (talk) 00:18, 21 October 2009 (UTC)

Cap Rate Contradiction

I think the person who wrote...

"A capitalization rate, or cap rate, does not equal the rate of return on an investment in real estate. Nor do investors consider only capitalization rates when evaluating real estate income property.",...

meant that you should also consider the appreciation on real estate in the rate of return on the "overall" investment. The comment is poorly written and it should be clarified that the "cap rate" measures the income while you own the asset and as earlier stated in the definition has nothing to do with the appreciation. The quoted comment should be deleted. —The preceding unsigned comment was added by Anotherforest (talk • contribs) 18:33, 10 April 2007 (UTC).

"The capitalization rate is calculated using cash flow, not net income. Generally, cash flow is defined as income (earnings) before depreciation and interest expenses:" Is there a source for this? I've seen the cap rate defined by net operating income by MAI designated appraisers before. williameis 16:30, 3 June 2007 (UTC)

This is an accounting truism: there are several ways to calculate net operating income, as revenue minus cash expenses (some reserves may also be subtracted to normalize cash expenses over the long term for "lumpy" maintenance expenses, like fixing a roof), or as net income plus non-cash expenses. Profit or income taxes (depending on the applicable tax regime) are generally also excluded (but expense-like taxes like property tax, water taxes et cetera are generally lumped in with cash expenses).

Or, to formulate algebraically:

Net operating income = Gross revenues - cash expenses = Net income + Profit tax + non-cash expenses (e.g. depreciation & amortization)

This is nothing more than a reformulation of the definition of net income:

Net income = (gross revenue - cash expenses) - non-cash expenses - profit taxes

As to the best way to put this in the article, it's a question of preference. This was presumably written to communicate simply that the income defition should exclude the primary non-cash expense.--Gregalton 06:25, 4 June 2007 (UTC)

The above explanation is not accurate, for real estate valuation purposes. Net Operating Income equals Gross Revenues minus all Operating Expenses. The writer(s) (of the explanation and the relevant portion of the article) is(are) confusing cash flow (an accounting measure from the cash flow statement), net income (an accounting measure from the P&L statement), and the set of terms commonly used in a real estate valuation (Net Operating Income, cash flow before debt service, capital expenditures, etc.). Net Operating Income is equal to gross revenues minus operating expenses. Capital expenditures (e.g., fixing a roof) are not the same as operating expense and should not be treated as such. They are distinct from an operating expense in the real estate valuation, in that they exist "below the line", i.e., after the NOI calculation. The correct term for NOI less capital expenditures is 'cash flow before debt service'. As for the application of cap rates, a cap rate always uses NOI as I defined it above. —Preceding unsigned comment added by 195.229.241.175 (talk) 10:29, 2 February 2011 (UTC)

CAP rate is before tax —Preceding unsigned comment added by 67.170.248.106 (talk) 21:38, 13 March 2010 (UTC)

Contradictions

There seem to be contradictions, because there are contradictions. The cap rate discussion isn't altogether internally consistent, and it's also not consistent with other finance/economics topics which mix-and-match terms. Finally, as some old sage said, "The US and the UK are two countries divided by a common language." Usage in the US doth not equal usage in the UK. Even though finance transcends national boundaries, cap rate is primarily a real estate term-of-art, and those do not transcend national boundaries.

If no one minds, I'll try to take a look at all of these definitions and work out some internal consistency issues, or at least append with some explanations of why the terms seem to mean different things in different contexts.

--Thesurveyor 01:19, 18 June 2007 (UTC)

Here's a starting point: What's a yield? Mclarent 22:36, 16 July 2007 (UTC)McLarent

Suggestions for tidying this up

1. Remove "Change of Value" section. Insert "The cap rate only recognizes the cash flow a real estate investment produces and not the change in value of the property." at introduction
2. Simplify "Cash flow defined" section, remove accounting language and refocus from a property perspective, i.e. "Gross Rent - irrecoverable expenses". Possibly include brief mention of lease terms dictating recoverability of costs

Any other suggestions? Mclarent 09:18, 19 July 2007 (UTC)McLarent

3. Include the link to this page that has a good article on Capitalization rate estimation techniques http://www.property-investing.org/capitalization-rates.html —Preceding unsigned comment added by 213.207.180.136 (talk) 16:31, 15 October 2008 (UTC)

Point #1 is not accurate. Cap rate does not "recognize" cash flow - it recognizes Net Operating Income. Again, the author here has confused accounting terminology with real estate valuation terminology. Real estate valuations deal with cash-related terms such as cash flow before debt service (NOI, less capital expenditures) and cash flow to equity (cash flow before debt service, less debt service). I suggest tidying up the "suggestions for tidying up" section by removing point #1. —Preceding unsigned comment added by 195.229.241.172 (talk) 07:51, 3 February 2011 (UTC)