If you're a commercial real estate investor (or aspire to become one), here's a key metric to keep in mind: capitalization rate (or "cap rate" to its friends). It shows the relationship between the Net Operating Income of a property and its overall value.
Let's say an office building sold for $20 million with an established net operating income of $400,000 a year. (Think of NOI as just pretax profits in running the building after all of its operating costs). So the capitalization rate in this case would an enormously expensive 2%. That is, the buyer paid $20 million for $400,000 in operating income...or 50 times that rate. Crazy expensive.
Cap rates exist as a vehicle with which to compare property investments. However, the cap rate alone doesn't tell the whole story. In most cases, the location of the building, its occupancy rate, the cost of debt on or attached to the building matters a lot.
The crazy cap rate of 2% that we talked about before might be cheap if the building was only half rented and the buyer was about to raise rent 30 percent on the existing tenants and bring in 30 more renters to "overnight" make NOI closer to $5 million than the $400k at which the building was running.
Cap rates represent a standard pricing metric in the industry. Think of the figure as analogous to the price per square foot in residential real estate. You could also use cap rates to look for trends in the commercial real estate market. If cap rates are going down, it most likely means values are going up, and if cap rates are going up the trend might be headed to lower market values.
Related or Semi-related Video
Finance: What is recapitalization?34 Views
finance a la shmoop what is recapitalisation all right people think
nee capitalization you know in Jersey like when you owe the mob money at least [thug breaks knee with bat]
that's what it feels like if you're a common equity stockholder of a company [businessman with common stock]
that has been recapped well usually recapitalisation is a very kindly loving
politically correct term for a pal you're bankrupt you borrowed money you
promised to pay back and you didn't so now you're out and the lenders now own
your company buh and buy so typical recap comes from a company that was very
early stage and had preferred stock upon preferred stock from venture capital
investors sitting above their common in the priority stack and eventually the
company burned through eighty seven million dollars and it has just a [dollars on fire]
million bucks left in the bank and it built something out of that eighty seven [company logo graveyard]
million not quite worth putting here yeah but it might be worthy of a new
investment of say yo thirty million or more dollars but the marketplace values [money going into company briefcase]
this zombie company yes that's what they're called at a [zombie briefcase walking at night]
value well less than the eighty seven million that has been raised previously
so everything is marked down usually with a common in total being worth [store during closing sale]
something like one percent of the new company and that's oh so sad for the
founders because it was a hundred percent of the company the day they
started so they were recapped and lest more mature companies feel left out well
recapitalisation happens in later stage companies as well and the radio industry
famously took on too much debt in the late 1990s and then people stop [radio knob getting changed]
listening to Drivetime radio as cell phones and satellite radio intruded I
bring radio borrowed five billion dollars at seven percent to oh three
hundred fifty million a year and then when cash earnings fell well below that
number while the company had to recap its five billion of debt such that those
debt holders now own essentially all of I brain radio and hope to someday milk
enough cash out of it to get their principal back knowing and it'll likely [goat getting milked]
be a very low interest rate or a low return on their and
if a positive one at all hopefully that all made sense you the first time though
because well we don't have time here in this video for a recap
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