Long-Term Debt To Capitalization Ratio

Finance allah shmoop what is capitalization rate Or cap rate

and know it has nothing to do with the percentage

of people wearing hats Cabaret is a pricing tool in

the sale of commercial real estate Specifically it is calculated

as net operating income divided by the property value Essentially

kappa rate is like a price to earnings ratio or

multiple but just applied to the unique foibles peculiar to

real estate It doesn't necessarily apply to say a silicon

valley software company Totally different metrics there like if a

seller has a building that produces three hundred grand a

year in n O I and they're asking for a

five percent cap rate well it means that they're asking

for six million bucks to sell you the building That

five percent figure is like asking for twenty times and

earnings like number in anna why they're in real estate

land In essence this five percent figure implies the rate

of return that the buyer of the building would get

if they invested in everything else was held steady State

like clients didn't leave a renter's didn't leave and pricing

of rent didn't change And taxes and operations and maintenance

and all your stuff didn't change And so on And

the twenty times number that we just got there without

was by dividing one hundred percent by five percent in

that twenty So yeah no mystery here Anyway the figure

here leaves out a ton of things Obviously things like

how fully occupied the building is when you buy it

and whether the building can or could or would be

fully occupied versus some number less than they'll say that

one hundred percent theoretical maximum occupancy today It also leaves

out how much in upgrades and maintenance stuff the building

needs at the diversity of its tenants I eat If

the owner of the building's relying on one tenant to

rent the entire building it's really risky Or if it's

on one industry well it's really risky Versus having lots

of different tenants in different areas of one industry dies

or one company dies is not the end of the

lease situation for the building And it also depends on

the length of tenant lease is already in place in

the building Like if all the leases come up or

are finished in three months well you may have a

problem you may have you know eighty two units or

however big the building is too suddenly rent and it's

good odds and the building stays empty for a while

Italy certainly not one hundred percent capacity okay and also

matters a ton in the pricing of a building whether

the overall area like geographic area is appreciating in value

and that rents khun b raised steadily for a long

time or not Yeah chernobyl is a hot real estate

market but you know different kind of heat And note

The kappa rates are kind of an inverse bond ish

calculation That is when kappa rates are high It means

that the y multiple is low like an eight point

two percent cabaret implies a roughly twelve times in a

y price on the building A cap a rate of

twenty percent implies on ly a five x multiple I'ii

something is very very wrong with the building like it's

losing it Zoning rights or needs t remove the s

bestest in the roof Anyway the bigger the better idea

here is that commercial real estate investors use better models

than just this cabaret thing They also used discounted cash

flow analysis to calculate the value of a building which

totals the risk adjusted future stream of cash profits to

the investors when they risk their own capital In buying

the building that figure has to take into account the

risk free rate iii the u S Government bond rates

and then it adds risk or risk premium to those

rates So if safe bonds are yielding three and a

half percent today the added risk of buying that building

might add another four percent a year in needed returns

Such a cap rate needs to be at least seven

and a half percent for the buying of the building

Teo even make sense many many complications here So for

the sake of clarity let's start with a better definition

of eno iron net operating income You own this building

It has one hundred offices all the same size which

rent for ten grand a year each or rather one

hundred percent aki given See here you have a theoretical

maximum of a million dollars a year in rental income

but today you're only an eighty percent capacity so you're

only getting eight hundred grand and you have expenses Insurance

Fifty grand janitorial service thirty grand heat water gas horning

ran real estate taxes forty five grand and other service

See things like fixing crap and mopping up goop on

the ground when someone bet wrong on the stock market

and uh you know pays their debts a different way

you know twenty five grand So then on eight hundred

grand in revenues the building has one hundred seventy k

year in operating expenses so that's eight hundred minus one

seventy That's six hundred thirty grand in profits And we're

done right No Why Well because almost all of real

estate carrie's dead often lots of debt In any rational

wall street investment you'd include cash and debt on the

balance sheet That part of the valuation methodology here right

But why wouldn't you in real estate Well because the

depth of pockets varies so much among fires some will

pay all cash and then refinanced the optimized tax deductions

on their own Others will just assume debt already in

place on the existing building like they'll just take over

the payments to that bank that's already made alone So

in order to not cloud the value of the operating

cash flows of the building most real estate Investors use

cap rates just to figure out the operating part and

then they add in and back out the dead and

interest on that debt and other investor related costs subsequently

Yeah so yeah that's capitalization rate which in tax written

by a thirteen year old yeah is nearly always zero 00:05:33.705 --> [endTime] percent