If you watched our latest Las Vegas Market Update, you know that Las Vegas was recently ranked #2 on Inman's "6 Hottest Places For Property Investment" List.
Our Vice President of Market Research, John McClelland, gives us an overview of the investment market, insight on why we made the list, and how to measure investment returns.
The single-family home as an investment attracts both individual and institutional investors. Home prices have more than doubled from their 2012 lows (measured by the S&P/Case-Shiller Home Price Index) and recently, prices have moved sideways. Despite no longer being the deal of the century or exhibiting near-term appreciation, single-family homes continue to attract investor attention, due in part to rapid increases in rental rates, expansion of available financing options and familiarity with the sector (as opposed to more exotic investment classes).
Since January, single-family rents have been growing between seven and nine percent year-over-year, while single-family home prices are roughly five percent higher. With seller’s becoming more accommodative relative to last year, investors have been able to find properties in excess of their return hurdles. So how do most investors measure returns?
Measuring Investment Returns
The most popular way to examine cash-flow properties are capitalization rates (“Cap Rates”). Cap rates translate net incomes relative to asset prices or costs and this helps investors examine returns of different types of properties. In its most simplified sense, cap rates are built by taking gross rental income, subtracting operating costs to make “net operating income” or “NOI” and dividing NOI with the purchase price or value of the property. Importantly leverage (i.e. loans, mortgage) are not included in the formula. These calculations should be done in annual terms. The determination of cap rates is a broad discussion and include property level market risks, access to capital markets, treasury yields, property age and expected rent growth. The Gordon Growth Model, often utilized for an understanding of stock prices also has an application here, for those readers coming from the public securities world.
For those looking for some “napkin” calculations, we typically see expense ratios from 35% to 45% depending on HOA fees, pools and other factors. So a quick way to examine a property is to determine its likely rent, multiply that monthly rent by 12 and multiply it by .65 or .55 (the portion you keep by removing the 35%-45% expenses) depending on a guess about the expenses. Then take that number and divide it by the asking price of the home. That generally gets you a ballpark figure to work with which will either encourage or dissuade further inquiry.
Rental Property Investments
Currently, we are seeing investors buy rental properties at cap rates between 3.5% and more rarely, in excess of 7%. The majority of transactions are closer to 5%. So while yield is important, not all investors buy for current yield but instead, they also look at the potential for the property through general or localized appreciation. That is why someone may buy a property yielding 3.5%, which is likely below investor mortgage rates. Below is a map of estimated cap rates across the Las Vegas Valley.
Similarly, some buyers purchase a home and lease it out with the expectation that they may ultimately live in the home themselves, so yield is only a secondary consideration. Some buyers make assumptions about appreciation and cap rates to develop more extensively, a targeted return on investment. Using more assumptions often implies higher risk, however, in markets that are competitive from both investors and owner-occupants, the strategy can pay off. Further, what makes sense on paper is often evaluated by reality as something different. A short Q & A with Kristi Pritchett, Vice President of Property Management, discusses some of these issues.
Summing up, cap rates are the single most common metric for analyzing property returns. Although gross rent multipliers, cash-on-cash and for some, a simple cash flow number are alternative ways of examining a property, cap rates are used nearly universally in our industry. For prospective investors, it’s a good starting point to make comparisons amongst several options.
For more information on investing in Las Vegas real estate, contact the Coldwell Banker Premier Realty Sales Professional responsible for sharing this blog post with you.