There are currently several key factors influencing the US real estate market: rising prices, unit sales, and housing inventories. The following is an excerpt from an article published by the Cameron School of Business at the University of North Carolina Wilmington, written by Dr. Edward Graham, Professor of Finance, Cameron School of Business (The article was originally shared on WilmingtonBiz.com on August 15, 2018).
“… The Case-Shiller Home Price Index, in Table I below, captures both the escalation in home values between 2000 and 2006, the correction in house prices as the housing bubble burst, and the recovery, on average, of the housing market across the US by mid-2018. Prices, on average across the US, more than doubled in the years ending in the spring of 2007. In the Cape Fear Region, using an admittedly informal but representative “index” created using home sales data provided by the Wilmington Regional Association of Realtors (WRAR), prices increased over 75% in the years ending in the spring of 2007. Prices then fell across the local market, but have since recovered. Few expected the recovery of the real estate market, in either Southeastern North Carolina or across the nation, to be as rapid as it has been.”
“… How do these data inform real estate investors? From an investor’s or a lender’s viewpoint, home prices relative to a property’s income have become lofty. A key metric employed by both real estate lenders and investors (these remarks may not apply directly to the traditional homebuyer) is the capitalization rate or “cap rate.” The cap rate on a real estate investment is simply the property’s net operating income divided by the price paid for the property. For example, if a newer but modest home in the Ogden area sells for $200,000, and rents for $1500 per month, it earns $18,000 (12 months x $1500 per month) per year in potential gross income. Assume operating expenses (this ignores vacancies and mortgage interest and depreciation taken for tax purposes) such as property taxes, insurance, maintenance and management total $8,000 per year; the property has a net operating income or NOI (its potential gross income minus expenses) of $18,000 – $8,000 or $10,000. The cap rate on this home is the home’s NOI divided by its value or $10,000/$200,000 = .05 or 5%.
With no financing, that 5% yield is the return that the investor will earn. That cap rate will support very little financing (investment property interest rates are close to or greater than 5%), and the property is a costly prospect for the new real estate investments student. Several years ago, as suggested by Table I, cap rates – even in the Cape Fear Region – of 8% or more were not uncommon; cap rates of 10% or more were briefly the norm in many areas. The real estate investor today needs to be far more patient, more selective, and more willing to accept a lower return than was the case in the riskier times of several years ago.”
A question in Response to this Article
Where is a source for finding real estate cap rates by the city?
I found your explanation of the residential real estate investment market very insightful. My question as a small residential real estate investor is where can I find Cap Rate comparables to use for analyzing each submarket. I’m afraid if I simply estimate operating costs and produce some sample cap rates manually using public comps, I will have too much room for error. I’ve found some professional sources for finding Cap Rates data by submarkets, but they all seem to be geared towards institutional investors. I’m looking for a reliable source of cap rates data and would be interested to hear if anyone else knows of a good one.
Answer: Where to Find Cap Rates Data
The following are the three leading providers of real estate cap rates data for the United States of America. Reis specifically provides real estate cap rates by city.
The real estate data services listed above are all offer paid access to databases of property data, including historical and current cap rates. I highly recommend Reis as a data source for real estate cap rates because of the services reliable data collection methodology. The platform offers decades of real estate data, all recorded and organized in a consistent format. This will offer a solution to question above about finding a reliable source for US real estate cap rates data.