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December 30, 2009

Cap Rate - 3 Simple Uses

What is Cap Rate?
Capitalization Rate, often referred to as "Cap Rate" by investors, is the ratio of net operating income (NOI) for an asset, to the asset's cost (most often real estate is the asset in question). When looking to buy real estate, Cap Rate can be used to do quick valuations on properties, or calculate the typical return of other properties that are comparable to the one you are looking at buying. To find the cap rate you use this formula:

C (Cap Rate) =  NOI (net operating income)
                                       V (Value/Cost)

So for example, if a 2 bedroom condo you are looking at will generate about $12,000 a year in net rental income (the NOI) per year, and the sales price (sold) of the property was $300,000. We can see the cap rate would be 4%. The forumla would look something like this:

(C) 4% =     (NOI) $12,000    
                      (V) $300,000

Do this on enough properties and you can start to get a good feel for what average cap rates are in different areas around you.

Cap Rate and Finding Value
Real estate investments are valued based on all kinds of criteria. Things like location, comparable property sales prices, land value, and the replacement cost to re-build the existing structure. Using the cap rate can give a simpler valuation with less variables, this can be handy when evaluating large numbers of properties. You can use cap rate to estimate value, or purchase price in this way:

(V) $171,428 =     (NOI) $12,000    
                            (C) .07 (estimated)

So if you do your due diligence and discover the average cap rate for properties you are looking at is 7%, and the income (NOI) of a particular property is around $12,000, then you can quickly estimate the average value of a property (using your estimated cap rate) to be around $171,428. 

Cap Rate to Compare Investments
If you find properties that are cash flowing around $12,000, and similar properties have sold with a cap rate around 7%, then you know that $171K is an average price for that type of property. 

If you are finding lower cap rates, that can mean less market risk, since the property is in demand. Higher cap rates usually show more market risk, as the property is not in as much demand. Properties in higher demand, often have positive factors that are driving the price of the property up, lowering the cap rate. Of course there are many risk factors to evaluate in a property, but cap rate can give you a broad, albeit, simple overview. 

Cap Rate and Realizing Opportunity Cost
It is wise, when finding a cap rate on a property you already own, to use the current price of the property to asses the cap rate, not the initial investment. The reason is it paints a more accurate picture of how your money is being used. For example, if I bought a property for $200,000, and it rents for $12,000/year, then the cap rate is 6%. But if the property appreciates to $400,000 5 years later, and rents increase to $18,000/year, I might be tempted to base the current cap rate on my initial investment since rents went up. The cap rate would then be 9%! Sweet! But, I would be forgetting the opportunity cost of having all my money tied up in that investment- $200K additional dollars now tied up in the property due to the price going up over time. Thats $200K "dead" dollars- money that is not working for me. If I look at the cap rate adjusted for current value it comes out to a 4% cap rate, not nearly as high as the 9% I thought I was getting. This could be a sign that I need to extract that $200K, or part of it, and put it to work in other investment vehicles or more real estate. Ideally as the property's price goes up over time, you want the NOI it generates to also increase over time, to maintain the cap rate at an acceptable level. 

Filed under  //   Investing   Real Estate  

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December 30, 2009

Net Operating Income and buying Real Estate

Net Operating Income (NOI) is the net income an asset will produce. Basically, if you have a rental for example, you take the gross rent, say $15,000 a year, and minus the expenses, say, $3000 a year. You are left with $12,000, which is the NOI. It is useful to figure out when buying real estate. Often people think figuring out NOI is only used for buying rental properties, but in fact, it is also useful for buying a property you wish to live in, not only as a step for figuring out a property's value, but also to see how you can reduce risk. 

Risk 
Figuring out risk, and knowing your risk tolerance is important before buying a piece of real estate, or any investment for that matter. Knowing how much you can rent a property for is obviously one of the many ways in which you can mitigate risk. If you lose your job or cant make payments or some reason, being able to rent out a property is a viable option to avoid risk of foreclosure. So it helps to look at your expenses and figure out what rental income you need to cover all expenses. 

Value
Figuring out NOI is also a step in figuring out the estimated Value of a property. Typically NOI is calculated by taking the gross rental income of a property and subtracting expenses like repairs, property tax, maintenance etc. You are then left with the NOI.

NOI typically does not include mortgage interest or depreciation as an expense since its more accurate to not include the amount of debt used to purchase the property. Debt amounts needed to buy a property vary, and depend on many factors. Excluding debt expenses leads to more accurate representations of value. 

Basically, NOI is calculated with the simple formula:

Gross Rental Income - repairs - prop tax - maintenance - other expenses = NOI

Once you have the NOI, you can use it to calculate Value and Cap Rate, which are also very useful in the purchase process.

Filed under  //   Investing   Real Estate  

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December 17, 2009

Anyone else buy the Dollar recently?

I posted a little while back about a technical (short term at least) bottom in the USD. It recently broke its downtrend on increased volume. I have been playing the pop with Options on the $UUP. Hard to say how long this pop will last though. The Fed. is still pumping some major liquidity into everything, and the 200dma is fast approaching. 


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December 7, 2009

Paradigms of the Cash Flow Quadrant

In a previous post, Why Paradigms are so important, I outlined the importance of paradigms in regards to tackling problems and improving results. Robert Kiyosaki's book, "Cash Flow Quadrant", a follow up to "Rich Dad Poor Dad, talks about four paradigms, and their relation to creating wealth. 

In this post, I will only be covering the basic paradigms of the cash flow quadrant and highly recommend Kiyosaki's "Cash Flow Quadrant" for a more in depth look into how the four paradigms- E-employee, S- sole proprietor, B- business person and I-investors- work. Of these, there are no wrong paradigms, they each have their own advantages and disadvantages. 

The E- employee for example: as an employee you are at the mercy of your boss, and your company, you get few tax advantages (in fact the largest expense you have in your life is most likely taxes), and the only way to get a raise or "move up the ladder" is if someone above you says its OK. You sacrifice your life (in hours of the day) to make money- in essence you are sacrificing freedom and control for "job security", and less risk (or today, at least the illusion job security). Money is not as important to you as security. This all seems negative, until you experience the paradigm shift of trying to start and run your own business, then the E doesn't seem so bad after all to many people, and in fact, most people at least start out here. 

In between the E and B paradigms lies the S- sole proprietor. The small business owners, professionals and contractors. These are often people who have moved from the E quadrant in search of freedom and independence- something you get little of in the flight to comfort that is the E. You get to pick your own hours (or so it seems at first) and you can charge whatever you want for your time (as long as you can get work at that rate). This seems like a holy grail for many people, and in fact for many it is. You do get more freedom and independence, and if you are in a field where you like to be doing the work (a technician) and garner the respect for it, like a doctor, a lawyer, artist, consultant, or an academic, this is most likely the way to go. You are in full control, and your success and failure is up to you and you alone. It is however a lot harder to start your own small business and run it, than it is to get a job working for someone else. Often times, being that the only way you can make money is, again, with your time, the only way to make more money is with more time, (or higher rates which are not always feasible). You do get some tax advantages, but then in some ways, you can also end up paying more taxes as well, so your mileage may vary. You also get no benefits except what you create for yourself. The main attraction here is freedom and independence along with the ability to do your own work (which you love), with an easy transition out of the E quadrant. 

Kiyosaki is understandably very adamant about people going the route of the B and the I. For business owners, freedom and independence is also a top priority. The difference is- of low priority, is the need to take credit for their work. In fact, they perform best when they surround themselves with people who are smarter than they are, that can do better work than they can. Something the E and S paradigms usually find a little intimidating. B's want to create systems, not do work. This doesn't mean they are lazy, in fact, usually they are workaholics because they love what they do. Its just that creating systems is their thing. A system does have several advantages once its setup. For one, if your system is working, it requires very little of your time and effort to run. 
McDonald's for example, is a system. Kiyosaki talks about this a lot in his books. They are not interested in making the best hamburger, they are interested in creating a system that sells hamburgers. And that system works very well. I think we all can make a better hamburger than McDonald's, but none of us can sell billions of them. So if your system doesn't need you to run, you don't have to be there very much, you can be doing other things while your system (business) is making money for you. 
Businesses also enjoy some of the best tax advantages, because it is the businesses that take the risks, and creates the jobs for the E's. The paradigm here is of not doing the work, but finding people that can do it well, building them up constantly, and leading them to greatness. To do this, you need to always be learning, improving yourself, and thinking outside the box. The downsides to the B paradigm, are the extreme difficulty of successfully starting a business, but for some people, this is where they are happiest. 

Those with the "I" paradigm are people who want money to work for them, they don't want to work for money. Those in the E,S, and B quadrants could also share the I paradigm, wanting to be investors and put their money to work in stocks, real estate or other investments. Those purely in the I quadrant are usually wealthy, or have a certain level of liquidity to be able to invest full time. This is the "fast lane", where you can snowball your wealth using the money you already have, investing in large deals- be they businesses or real estate investments. They also want to avoid the expense of taxes as much as possible and just pay their fair share. The main difficulty of entering the I quadrant, even if you have the right paradigm for it, is building the capital to invest. Often, because of this major obstacle, you usually have to start elsewhere in the E,S or B quadrants.

Everyone has a different view on the best methods for creating personal wealth (making money) for themselves. As mentioned above, there is no wrong paradigm, with one exception- if you really want to be in a different quadrant. If you are in the E quadrant for example, and want to get into the B quadrant, this will first take a shift in paradigms, or you will have a very hard time. Being in a quadrant of your choice has less to do with what you know or what skills you have and more to do with how you "see" work, money, and the world around you. The paradigm is the root. 

 

Filed under  //   Business   Investing   Paradigms  

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December 4, 2009

Technical bottom reached in the dollar?

Oil has been in a little slide as of late, and gold took a hit today. On the charts, the dollar is hitting a key technical support level. Whether it holds this level or not is obviously unknown, but although the Fed. is printing it into oblivion, the central banks of some countries have indicated they might intervene in the dollar if it falls too far, Japan being one country in particular with a serious need for a strong dollar. 


Filed under  //   Investing  

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October 16, 2009

-I shorted more $CHK calls this week

I have been making some nice Theta credit with Calendars the past few months with $CHK as its been gaining strength. Im not really sure why since inventories are high, but maybe its all the Eco hype that Nat. gas has been getting? not sure, don't care. But the premiums are high, and decent resistance near $30 so its ripe for churning the calls around that strike. I sold some $32 strikes for 15% gain. If I get called, Ill make 70+% on the underlying + the 15% in premiums. If I dont get called, I'll try and short more calls on volatility spikes here and there. These types of trades are good to get in low, as when you carry the underlying, you dont have much downside protection other than your stop loss, or buying a put, which takes more management (trade adjustment). If you get into the position low enough, it mitigates much of the risk, and you can just sell Theta each month for a little cash flow. Get in too late in the movement of the issue, and the trade becomes much riskier, even when taking in the premiums. Get into a Calendar early enough, and stick with it long enough, and you can end up with a free trade that keeps on paying you premiums every month, this is ideal. 

I've also been in and out of $AAPL and $OIH, some delta neutral trades on those names. I also track some ETFs, but have not had time to find some that suit my style of trading yet, too busy with other things right now. Trading is fun, much like a video game, but you need lots of time to really play well. Its a business too after all...

Filed under  //   Investing  

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