CAP rate and financing CAP rate difference

Willyboy

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Aug 19, 2016
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#1
Good evening everybody. I was just checking some proforma on apartment buildings in different cities in Canada and I noticed some proforma have two CAP rates, one is called CAP rate and the second is called financing CAP rate.

Example: Price: 850,000
Revenues: 64,440
Expenses: 27,166
DCR CMHC: 1.3
Amortization: 30 years
Interest rate CMHC: 3.5
Down payment CMHC: 317,000
Cash on cash: 2.3%
Cash on cash + principal: 5.7%
IRR with 2% appreciation: 11%

CAP rate: 4.4%
Financing CAP rate: 5.94%

For me this doesn't sound like a good investment but I'm just curious what's the difference between the two CAP rates is and which one should one normally go with to decide? What grabbed my attention is the difference is big.

Vancouver and Toronto are overvalued so I forgot about them. In Calgary and Edmonton in particular where I'm interested right now there's nothing available. So I thought I would check Montreal out of curiosity to see what the numbers look like where the above example is from but I realized the prices compared to rents are overvalued as well.
 

ThomasBeyer

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#2
Value or price is what someone is willing to pay. While you might find them overvalued others might not. Where do you buy?

Clearly there is plenty of inventory for sale in Calgary and Edmonton. As such your statement “nothing is for sale” is based on what?

Why do you think these markets are overvalued? Compared to what benchmark ? Historic norms? Last year’s value? 1985 value? Rent to price ratio ?

I don’t know what a financing CAP rate is. Why don’t you ask the listing realtor as it is an unusual phrase to use. Maybe he means a CAP rate with different expense and rent assumptions.
 
Last edited:

Michel Lafleur

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Apr 30, 2015
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#3
Cap rates are easy to figure out; its a way of measuring a proeprty's performance as if you paid cash for it. Its annual net operating income/purchase price.
Gross income = $64,440
Annual expenses = $27,166
Net operating income = $37,274/ year
If purchase price = $850K, then cap = 4.4%...... 37,274/850,000 = 4.385%.... this is your cap rate.

Im not certain about financing cap rate. My assumption is that this is using the same equation, but uses cash out of pocket amount (deposit + appraisal fee and/or CMHC fees, etc) instead of purchase price.

If you are more familiar with residential analysis where most people calculate cashflow using 75-80% financing.... this would be a negative cashflow scenario.
 

Willyboy

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#4
Value or price is what someone is willing to pay. While you might find them overvalued others might not. Where do you buy?

Clearly there is plenty of inventory for sale in Calgary and Edmonton. As such your statement “nothing is for sale” is based on what?

Why do you think these markets are overvalued? Compared to what benchmark ? Historic norms? Last year’s value? 1985 value? Rent to price ratio ?

I don’t know what a financing CAP rate is. Why don’t you ask the listing realtor as it is an unusual phrase to use. Maybe he means a CAP rate with different expense and rent assumptions.
Thanks Thomas, appreciate the reply. I agree with you that value is subjective. Why I think they are overvalued though, is because I'm taking a cash flow investor's perspective I mean where cash flow is negative and CAP rates are low and price to rent ratio is way higher than it used to be in the last two decades for investment properties specifically. And regarding regular houses I'm looking at median wages to compare where in Vancouver and Toronto the ratio of house prices to median wages is very high specially now that the interest rate is creeping up even though slowly.

Regarding Calgary and Edmonton I think I made a typing mistake where instead of saying there's nothing good with numbers that make sense available I just said nothing available and I assumed it should be interpreted the way I mean it but it's my fault I just missed that. I'm talking about multifamily investment properties here and not single houses or condos because definitely the inventory of houses and condos is very high and lots of them are available now but when I checked the multifamily on the MLS there's not too many and honestly I relied on previous threads where investment experts said it was hard to find good ones.

And you're right I should contact the realtor and ask them about this financing CAP rate.
 
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Willyboy

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#6
Thanks Thomas. I will try to get in touch with a few of the names I came across here in the forum.
 

Willyboy

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#7
Cap rates are easy to figure out; its a way of measuring a proeprty's performance as if you paid cash for it. Its annual net operating income/purchase price.
Gross income = $64,440
Annual expenses = $27,166
Net operating income = $37,274/ year
If purchase price = $850K, then cap = 4.4%...... 37,274/850,000 = 4.385%.... this is your cap rate.

Im not certain about financing cap rate. My assumption is that this is using the same equation, but uses cash out of pocket amount (deposit + appraisal fee and/or CMHC fees, etc) instead of purchase price.

If you are more familiar with residential analysis where most people calculate cashflow using 75-80% financing.... this would be a negative cashflow scenario.
Thanks Michel for your input. I am actually familiar with cash flow analysis and yes you're right that this would be a negative one on a 20% down payment.

Regarding this financing CAP rate it could be that they are using different metrics like Thomas and you said but I will try and contact them to see what they say just out of curiosity.
 

RedlineBrett

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Oct 24, 2007
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#8
Financing CAP rate is not a broadly accepted industry term. It's quite likely the realtor's own spin on the cap rate economics by using 'stabilized' rents. So when you have a building that is rented 'under market' most salespeople will prepare economics based on 'stabilized rents' or what the rents 'could be' if you made some investments in the building or took a more aggressive approach with the leasing.
 

Matt Crowley

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Dec 14, 2013
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#9
Financing cap rate could mean a higher cap rate that will be used by the lender than will be used to value and sell the asset - and it is something used by CMHC.

Edmonton / Calgary very challenging to make sense of in-place assets. Most guys expanding portfolios in multi in Alberta are building not buying in place: Strategic Group, Bentall Kennedy, Arlington Street. Lots of old, tired rentals in cities with relatively cheap land and lots of sprawl internal and external.

Cap rates are useful and part of the framework in real estate. But really IRR and multiples should be the focus within the time it takes for you to accomplish the business plan. Then you sensitize the cap rate, rental growth assumptions, and determine if it is worth it.

No chance I would be investing on an 11% underwritten IRR. Much safer and easier returns putting $1 into RRSPs, turning it into a $1.30 and onto a REIT if I am desperate for real estate exposure.