Basic things you should know about reverse capitalization rate

If you are an experienced investor in commercial real estate, you would be familiar with the term reverse capitalization rate. It is a tool that helps you decide the price of your property during its exit or sale. The exit value refers to the resale price of your property.

Investors cannot predict the future and have no way of knowing what their properties will sell for at the closing of a deal. The cap rate, which analyzes the risks involved with the exit sales value, is the most reliable method they have.

Although you will find more details about this topic here, it is vital to have a general idea about the influence reverse cap rate has on exit value, the calculation method, and the factors that influence it. It also has some importance for you as a passive investor in multifamily Class B and C properties through real estate syndication.

If this is your first time investing in commercial real estate and you are largely unfamiliar with these terms, here is some information that will help you get started.

reverse capitalization rate

An introduction to reverse cap rate

As mentioned above, the reverse capitalization rate comes into the picture when you stress-test the exit value of a property deal or its ability to absorb risks during the sales period.

It is the safest way of determining the exit value, generally done by increasing the capitalization rate (used to measure the value yielded by property for a year against its current value) by a minor percentage.

What is the going-in market cap rate?

The going-in market cap rate refers to the value at which commercial properties like yours sell in the property market. Experienced equity firms usually increase their cap rate by at least 0.5%, or 50 basis points higher than the going-in cap rate.

It is crucial to use a cap rate that decreases the projected exit value, as that provides a good idea of the rate of return on a project.

Difference between the terminal and going-in cap rate

There is a slight difference between the two terms. While the terminal capitalization rate refers to a property’s resale value at the end of a holding period, the going-in is the rate at which you acquire a property.

The going-in rate is also known as the entry rate (it’s obtained by dividing the NOI by its current market value).

What factors affect the cap rate?

Several factors affect the reversion cap rate, including the risk level, present debt, equity, time left till the projected exit, existing market conditions, and property type.

Other factors that equally affect the capitalization rate are the prevailing economic conditions of the place where you purchased the property and its geographic location.

Its relevance in passive investing

The reverse cap rate is equally important if you are into passive investing in multifamily properties through real estate syndication. The syndicator or the equity firm that manages the deal ensures that a property’s cap rate is similar to others in your area, thus minimizing the risks of financial losses.

Does it have any limitations?

The reverse cap rate is a reliable tool to underwrite the exit value or assess its risks. However, your deal or investment can still be affected by macro-economical events or local events that impact your property’s value during the selling period.

Even though you should find more details about this topic before investing in commercial property to help you make informed decisions, the information given above will give you a basic understanding of the topic. Using the reverse cap rate is a reliable way of minimizing the risk of losses in the future.

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