Investors are continually seeking ways to acquire property with the least possible cost of capital (interest rate charged on a mortgage). The cost of capital has a direct impact on the investment return that a property will generate for a buyer.
For example, if the investor has to pay 4% for rent of the money/capital (interest on the loan), then they have to earn in excess of the 4% to realize a profit. The benefit has to exceed the cost. Consequently, if the cost of capital (interest rate) increases, a buyer coming into the market will envision the need for an increased net operating income in order to meet a desired profit margin.
If the spread between mortgage interest rate and cap rate is normally 2%, (interest rate is 4% and the cap rate on the investment is 6%) and then the mortgage interest rate increases from 4% to 5% due to outside market influences, then the cap rate would have to increase from 6% to 7% for that same asset to maintain the desired spread.
Those who are buying with too thin of a cap rate (spread) may find that they may have to sell at diminished value, even if that property is producing the same amount of gross income and net operating income. The property did not become less valued, but the cost of the capital made it less desirable.
How to Minimize Cost of Capital
Shop for the best financing terms available when purchasing or refinancing. The cost of capital will have one of the biggest impacts on your rate of return. Ask your trusted Real Estate Advisor for a referral to a good lender. Do not take your first offer unless it is too good to be true.
Occasionally a local bank or lender will offer cheap rates or low to no fees because they are trying to buy business that month but it is pretty rare. All of the lenders typically get their money from the same source (Government sources like Fannie Mae). You want to obtain at least three lending options so you can see your best options and make a smart decision. Remember…. many investors will own a real estate asset at least five to seven years. The time you take to shop for the best rates will pay off not only today but for years to come.
Recent Comments