Understanding Cap Rates:
Cap Rates and Strategic Investment
If cap rates fall below the level of the mortgage interest rate, then reverse leverage is created, in which the mortgage leveraging is magnifying the negative cash flow – the cost of financing is working against the investor. Don’t buy a property with an extremely low cap rate, especially lower than your mortgage interest rate, unless there is strong upside potential, additional excess or surplus land which can be developed, or other “value add”. If the cap rate is less than the current mortgage rate and you can pay cash, then pay cash and don’t take out a mortgage. If you believe the cycle has topped out and cap rates are at their lowest point in the cycle, then sell.
Land is best bought with cash and not a mortgage.
Anticipating the Future Value
Values are anticipations of the future, as are most things in life.
Risk and Reward
The higher the risk, the higher the cap rate.
The lower the risk, the lower the cap rate.
Risks, Rates, and Returns
Navigating FEMA Floodplain Maps
FEMA floodplain maps – they don’t always show areas of potential flooding. Be careful using FEMA floodplain maps. Use your eyes in the field and make common sense judgments. If there is a drainage ditch located on your property, but the FEMA floodplain map doesn’t show this drainage ditch, this ditch still could flood, especially in times of heavy rains, and this drainage ditch should be disclosed in your appraisal report. Floodplain insurance may be available for properties, check with your insurance agent to find out. The cost of floodplain insurance premiums is trending upward.
ESA = Environmental Site Assessment
A Phase I ESA is an inspection and written report by an environmental inspector. A Phase II ESA is actual soil, subsoil, or other tests, such as asbestos sampling. A Phase III ESA is the actual removal or remediation of an environmental hazard, such as the removal of a leaking underground fuel tank and all the associated contaminated soil.
Terms with Same Meanings
NOI = Net Operating Income = EBITDA = Earnings Before Interest, Taxes, Depreciation, & Amortization. All of these terms mean the same thing.
Understanding the Lingo
The property being appraised is called the “subject property” or simply the “subject”.
The Power of Appraisals
An appraisal is an opinion of value rendered by a professional licensed real estate appraiser. Appraisals are very valuable. In addition to the current value of the property, the appraisal report will provide client with a detailed description of the appraised property, maps, aerial photographs, ground level photographs, zoning information, floodplain information, and much more. Appraisals are “cheap insurance” for the lender, borrower, buyer, seller, and broker. An appraisal will ensure that a seller doesn’t sell the property too cheaply and “leave money on the table”. An appraisal will ensure that a buyer doesn’t pay too much for a property.
Timing for Property Inspections
The best time to inspect a property that you want to buy is during a hard rainstorm, that way you will know where the leaks are located.
Request a Consultation
We look forward to helping you with your unique appraisal needs in Texas.