Blog | Investing
Why Do Investors Buy Low Cap Rate Investment Properties?

by | Dec 14, 2020

Low cap rate Investment Properties seems to be a goldmine in real estate investment nowadays. Calculating capitalization rate might not be the easiest thing to do, asking different people in real estate about capitalization rate will give you different and probably conflicting answers.  A capitalization in real estate is used to indicate the rate of return that is expected to be recouped from a property. This measure is computed based on the net income which the property is expected to generate and is calculated by dividing net operating income by property asset value and is expressed as a percentage. The formula for cap rate is “Capitalization Rate = Net Operating Income / Current Market Value” It is used to estimate the investor’s potential return on their investment in the real estate market.A very simplistic approach to understanding capitalization rate or cap rate as it is commonly known is to understand that the lower the cap rate the more expensive the property is.

Why Capitalization rate is important to you?

Location: capitalization rate will vary depending on the location. Busy urban locations will typically generate lower cap rates due to the high demand for investment properties (higher property prices) and low associated risks compared to rural locations. Investors are usually willing to pay more for properties in major cities because they perceive them to be less risky due to stronger demand.
Property Type:  Cap rate will differ depending on the property type.  Multifamily properties have low capitalization rates due to the minimal risk they bring. Multifamily generate monthly income from multiple tenants, so delay from a few tenants may slightly dent revenue for that month but the scenario will be different if the property were a single luxurious mansion rented out to a single-family and they default in payment. 
Timing: The timing of the market is also important in analyzing cap rate. Typically in a buyer’s market, the cap rates will be higher due to cheaper property prices. it can be deduced that a good cap rate will depend on the timing of the market whether it swings in the favor of the buyer or seller.

How does Low Cap Rate benefit you?

There’s a huge preference to rent among millenials and even the upcoming Gen Z, the demand for residential rental property is on the increase. Some of the benefits of low cap rate investment properties include :

Stability :The stability that comes with investing in residential rental real estate encourages more investors in real estate to be more bullish and be less frugal in spending on Net Operating Income (NOI) rather than put their investment capital at risk.

Increase in value: its easier to add value to Low cap rate investment properties by increasing net operating income(NOI). Increasing NOI results in much larger growth in property value and equity in a low cap rate market.

Value Repository: Low cap rate Investment properties are value repository of sorts. By increasing their NOI the value of the property is increased which means you can sell it for a higher price when you want to sell and make considerable gains.

In conclusion, Having a low cap rate on properties ensures that you can safely and smoothly make investment exits. A starting point is to identify hot spots or markets with low cap rates and find properties and owners within that market.

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