WHY RISING INTEREST RATES DEGADE THE VALUE OF INCOME PROPERTY
With inflation seemingly going higher by the minute the Federal reserve has continued to raise interest rates on interbank borrowing which reverberates through 10-year Treasury yields now 4.12% and eventually to real estate loans now above 7%. The Fed is scheduled to meet 3 more times this year next on September 20. Cap rates tend to follow interest rates but not directly. A cap rate is a valuation method used to price income properties and is calculated by dividing a property’s annual net operating income (NOI) by its value. So for example a 6plex that has an NOI of $36,800 and sold for $736,000 had a cap rate of 5%. In the past 10 years cap rates on many income properties were steadily dropping to 5% or even less in some expensive venues like California thereby increasing the sale price even with stagnant or falling NOI. While cap rates assume free and clear properties (no debt), cash flow requires subtracting the annual debt service (mortgage payments) from the NOI. When market cap rates exceed the debt service rate this is called positive leverage and allows an owner to typically make money not only on his own investment (down payment) but a return on the lenders mortgage (cap rate less mortgage rate). These days are over. Cap rates are rising nationally and now we are seeing some income property sitting on the market. That 6plex I mentioned earlier will now likely not sell for less than a 7% cap rate or $526,000 assuming the NOI is constant. If a new buyer can get a mortgage for 7% this is called neutral leverage. Once mortgage rates exceed the cap rate you get a situation called negative leverage and negative cash flow. Most income property owners are facing expenses (especially taxes and insurance) rising faster than income which creates a double value knock down with decreasing NOI and increasing cap rates and mortgage rates. Additional political risks exist in certain venues. CA just passed legislation that put a 5% cap on rental increases even on single family homes. This spells future trouble for that market. Foreclosures anyone?
BY CHUCK WEST, CCIM AUTHOR AND EDITORForever West
SEPTEMBER 2023
follow me on twitter @cwestucla
WHY DO I NEED TITLE INSURANCE WHEN A WARRANTY DEED IS GIVEN BY THE SELLER?
LEGAL CORNER
Title Insurance can help ensure that title defects will not make a property unsaleable in the future because of: 1. Forged Documents 2. Undisclosed heirs to the property 3. Mistaken legal interpretations in wills 4. Misfiled documents at the county 5. Confusion due to similarities in names 6. Incorrect marital status 7. Mental incompetence of the grantor 8. Discrepancies in parcel boundaries (which may require a survey), covenants (that maybe violated by actual inspection of the property). The title company will show he recorded covenants but will not ensure that they have not been violated. This is the buyer’s duty. Maybe more practically speaking can you afford to sue the seller?
FEATURED PROPERTY
of 10 million square feet of commercial properties on a national basis and as Director of Real Estate for two large counties handling 14 Million square feet of leased space and 50 million square feet of government owned space.
THE WAYWARD WIND
“Try to remember the kind of September when life was so tender that no one wept except the willow.”
- Andy Williams “The Fantastics”