The relationship between loan interest rates and capitalization rates (cap rates) is an important one because typically when interest rates increase, so do capitalization rates, resulting in a loss in property value.
A rise in interest rates primarily impacts investors in two ways. First, as rates rise, the rate of return an investor can expect on their investment will go down as more money is being paid to interest and is not received as cash flow. Secondly, as rates rise, the loan-to-value (LTV) is also significantly impacted. An investor should expect to put down larger down payments than they would have had rates stayed flat or gone down. As an investor’s rate of return decreases, and loan amounts also go down, capitalization rates tend to rise with interest rates which results in a loss of property value. As interest rates continue to rise the value of your property may continue to fall, however there are steps you can take today to preserve your equity and continue to have a strong performing portfolio. We can help!
Definitions
Net Operating Income (NOI): Gross annual income – annual operating expenses = NOI
Capitalization Rate (Cap Rate): Expressed as a percentage of the net operating income relative to the sales price.
Example: Net operating income = $50,000. Price = $1,000,000. $50,000/$1,000,000 = 5% capitalization rate
Loan to Value (LTV) = The size of the loan relative to the purchase price.
Example: Price = $1,000,000. Loan amount = $600,0000
$600,000/$1,000,000 = 60% LTV
A loan of this amount would require a $400,000 down payment
Average Cap Rates per Market*
Generally speaking, the lower the cap rate, the more desirable the market as investors will accept a lower percentage to be in a more desirable area.
Santa Clara County: 4.42%
San Mateo County: 4.14%
Alameda County: 4.87%
*Cap Rates per market are based on data collected by CoStar.
Using the Calculator
Step 1: Determine your NOI and enter it into the calculator.
Step 2: Determine your Cap Rate and enter it into the calculator. (see general guidelines below)
Step 3: Contact us if you get stuck or have any questions. We’re here to help you!