Category: FY Minute

Commercial Real Estate (CRE) Investor Question #90: What is the difference between rental yield and cap rate?

Rental yield is the net amount of money a landlord receives in rent over one year (after deducting operating expenses), shown as a percentage of the amount of money invested in the property.

So, Rental Yield = (Net Annual Rental Income / Cost) X 100

Note that rental yield is calculated on Net Operating Income without considering interest payment, tax and depreciation.

Cap rate (or capitalization rate) is the ratio between the net operating income produced by a real estate asset and its cost (or current market value).

So, Cap Rate = Net Operating Income / Value (or cost)

If you notice, both rental yield and cap rate appears to be same!

Rental yield is used to calculate the yield (return) of an asset whereas the cap rate is used to find the value (capitalized value) of an income generating real estate asset.

Source: https://www.feasibility.pro/real-estate-analyst-interview-questions-answers/

Commercial Real Estate (CRE) Investor Question #90: What is the difference between rental yield and cap rate?

Rental yield is the net amount of money a landlord receives in rent over one year (after deducting operating expenses), shown as a percentage of the amount of money invested in the property.

So, Rental Yield = (Net Annual Rental Income / Cost) X 100

Note that rental yield is calculated on Net Operating Income without considering interest payment, tax and depreciation.

Cap rate (or capitalization rate) is the ratio between the net operating income produced by a real estate asset and its cost (or current market value).

So, Cap Rate = Net Operating Income / Value (or cost)

If you notice, both rental yield and cap rate appears to be same!

Rental yield is used to calculate the yield (return) of an asset whereas the cap rate is used to find the value (capitalized value) of an income generating real estate asset.

Source: https://www.feasibility.pro/real-estate-analyst-interview-questions-answers/

Commercial Real Estate (CRE) Investor Question #89: Is real estate / housing a good hedge against inflation?

Yes, real estate or housing is a good hedge against inflation. Ben Carlson, a popular portfolio manager has an in-depth article on this question. Here’s a picture from his book on how inflation “destroys” wealth. On the flip side, having a mortgage can help counteract those interest payments over time.

Commercial Real Estate (CRE) Investor Question #88: What are the key elements of property value? What are the top valuation methods?

Real Estate Property Value consists of the following key elements:

Demand: the desire or need for ownership supported by the financial means to satisfy the desire.

Utility: the ability to satisfy future owners’ desires and needs.

Scarcity: the finite supply of competing properties.

Transferability: the ease with which property ownership rights are transferred.

Source: Reonomy

The key methods of property valuation, some of which we’ve seen earlier, are:

• Income Approach – Based on income generated by the property
• Sales Comparision Method – Based on comparable (comps) property sales
• Cost Method – Based on the cost of building

A detailed article on the above methods is available at Reonomy!

Commercial Real Estate (CRE) Investor Question #87: I would like to get exposure to real estate asset class through REITs. Where do I start?

We’ve seen that REITs or REIT funds are a popular way to invest in real estate as they behave like stocks and can be bought through various brokerages. Many of the brokerages (for e.g. Fidelity, Merrill, Charles Schwab et.) also provide material and research on REITs as they do for stocks of companies.

You can research and trade with your brokerage. Another great resource to understand the world of REITs is Nareit. It provides a listing or directory of REITs and you can search and research based on various criteria as shown below.

Nareit also provides a list of REIT funds in addition to various other resources to get started with your research.

Commercial Real Estate (CRE) Investor Question #86: What is preferred equity and should I invest in preferred equity?

We’ve seen the CRE capital stack in a previous post and how preferred equity is a part of it. We’ve seen that preferred equity is a debt/equity hybrid that resides in the third position of the capital stack.  It is more senior than common equity but less senior than all forms of debt (Senior and Mezzanine).

It is important to understand the risk and characteristics of preferred equity compared to the rest of the stack. PropertyMetrics explains preferred equity in detail and compares it to the rest of the capital stack.

Risk level, repayment prioritization, and return expectations:

Risk Level:	Medium – High
Repayment Prioritization:	3rd
Return Expectations:	8% – 10% + “Kicker”

Characteristics of Preferred Equity

Further explanation of preferred equity can be found in the same article. We highly recommend going through the entire article and getting familiar with the capital stack and preferred equity in particular.

Preferred equity serves a similar function to mezzanine debt in that it is meant to fill the gap between senior debt and common equity

In return for the risk associated with making a preferred equity investment, the investor is compensated with a steady return in the form of annual payments (like debt) as well as an opportunity to participate in the upside of the project should it meet certain performance goals (like equity).  

The performance goals are clearly outlined in the investment contract and typically establish a threshold, above which an equity “kicker” allows the preferred equity holder to participate in additional profits.

Source: https://propertymetrics.com/blog/capital-stack/

Commercial Real Estate (CRE) Investor Question #86: What is preferred equity and should I invest in preferred equity?

We’ve seen the CRE capital stack in a previous post and how preferred equity is a part of it. We’ve seen that preferred equity is a debt/equity hybrid that resides in the third position of the capital stack.  It is more senior than common equity but less senior than all forms of debt (Senior and Mezzanine).

It is important to understand the risk and characteristics of preferred equity compared to the rest of the stack. PropertyMetrics explains preferred equity in detail and compares it to the rest of the capital stack.

Risk level, repayment prioritization, and return expectations:

Risk Level:	Medium – High
Repayment Prioritization:	3rd
Return Expectations:	8% – 10% + “Kicker”

Characteristics of Preferred Equity

Further explanation of preferred equity can be found in the same article. We highly recommend going through the entire article and getting familiar with the capital stack and preferred equity in particular.

Preferred equity serves a similar function to mezzanine debt in that it is meant to fill the gap between senior debt and common equity

In return for the risk associated with making a preferred equity investment, the investor is compensated with a steady return in the form of annual payments (like debt) as well as an opportunity to participate in the upside of the project should it meet certain performance goals (like equity).  

The performance goals are clearly outlined in the investment contract and typically establish a threshold, above which an equity “kicker” allows the preferred equity holder to participate in additional profits.

Source: https://propertymetrics.com/blog/capital-stack/