Cap Rates Vs. Interest Rates - 'Negative Leverage?'

August 14, 2024

We sourced this from a reknown Multi-Family Investment Real Estate Agent, Chris Davies with RE/MAX Commercial Capital.

To give some perspective on the Opportunities out there. Many investors find the opportunity lies in the current proforma. However, in entrpreneurship, the opportunities can lie in the solution to any given problem where a benefit can be realized from a product or service solution. 

"Negative leverage" in real estate investment, is where the property’s cap rate is lower than the interest rate, leading to reduced returns. This situation often causes concern for investors, especially when debt is at 5.5% and the property offers a 4% cap rate. However, purchasing such a property can still make sense if the plan involves quickly improving the income (e.g., through rent increases) and perhaps reducing expenses to move into a positive leverage situation. Also taking into account, inflation as time progresses. 

Key points:

1. Negative Leverage: Borrowing when the cap rate is lower than the interest rate reduces returns but can be part of a broader investment strategy.
2. Interim Financing: Temporary financing can be used until the property reaches positive cash flow.
3. Value-Add Strategy: Investors must focus on how quickly they can raise income, especially within the first few years

A long term analysis plan should be considered. Not only should the business be stabilized for positive cash flow, the building itself should be sustainable for a future sale and equity retention. Buyer's will ultiimately pay more for a property with good returns.

For any resale or refinance consideration would be considering the market. Are values recessed or in an upswing? Timing is a factor as well.

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