See: Capitalization Rate.
It’s just a metric. It kinda speaks to the financial solvency of the company, in that there will be an easily deducible interest rate from that debt. The capitalization of the company usually refers to the balance sheet line Shareholders Equity, or something like that.
It can also refer to the market capitalization of the company. Like…say a company has $100 million in debt and 50 million shares outstanding, and the company’s shares trade today for $40 each. The company then has a $2 billion market capitalization at this moment, and the notion of paying off $100 million is pretty easy, right? That total debt is only 1/20th of the total market cap of the company. If they had to sell 5% of their equity to raise cash and be completely debt-free, it likely wouldn’t be all that hard.
And yes, you can imagine the opposite scenarios. They get ugly. So you generally want your long-term debt to cap ratios to be…small. Like your level of solvency worry before you go to bed.
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Finance: What is Capitalization Rate?3 Views
Finance allah shmoop what is capitalization rate Or cap rate
and know it has nothing to do with the percentage
of people wearing hats Cabaret is a pricing tool in
the sale of commercial real estate Specifically it is calculated
as net operating income divided by the property value Essentially
kappa rate is like a price to earnings ratio or
multiple but just applied to the unique foibles peculiar to
real estate It doesn't necessarily apply to say a silicon
valley software company Totally different metrics there like if a
seller has a building that produces three hundred grand a
year in n O I and they're asking for a
five percent cap rate well it means that they're asking
for six million bucks to sell you the building That
five percent figure is like asking for twenty times and
earnings like number in anna why they're in real estate
land In essence this five percent figure implies the rate
of return that the buyer of the building would get
if they invested in everything else was held steady State
like clients didn't leave a renter's didn't leave and pricing
of rent didn't change And taxes and operations and maintenance
and all your stuff didn't change And so on And
the twenty times number that we just got there without
was by dividing one hundred percent by five percent in
that twenty So yeah no mystery here Anyway the figure
here leaves out a ton of things Obviously things like
how fully occupied the building is when you buy it
and whether the building can or could or would be
fully occupied versus some number less than they'll say that
one hundred percent theoretical maximum occupancy today It also leaves
out how much in upgrades and maintenance stuff the building
needs at the diversity of its tenants I eat If
the owner of the building's relying on one tenant to
rent the entire building it's really risky Or if it's
on one industry well it's really risky Versus having lots
of different tenants in different areas of one industry dies
or one company dies is not the end of the
lease situation for the building And it also depends on
the length of tenant lease is already in place in
the building Like if all the leases come up or
are finished in three months well you may have a
problem you may have you know eighty two units or
however big the building is too suddenly rent and it's
good odds and the building stays empty for a while
Italy certainly not one hundred percent capacity okay and also
matters a ton in the pricing of a building whether
the overall area like geographic area is appreciating in value
and that rents khun b raised steadily for a long
time or not Yeah chernobyl is a hot real estate
market but you know different kind of heat And note
The kappa rates are kind of an inverse bond ish
calculation That is when kappa rates are high It means
that the y multiple is low like an eight point
two percent cabaret implies a roughly twelve times in a
y price on the building A cap a rate of
twenty percent implies on ly a five x multiple I'ii
something is very very wrong with the building like it's
losing it Zoning rights or needs t remove the s
bestest in the roof Anyway the bigger the better idea
here is that commercial real estate investors use better models
than just this cabaret thing They also used discounted cash
flow analysis to calculate the value of a building which
totals the risk adjusted future stream of cash profits to
the investors when they risk their own capital In buying
the building that figure has to take into account the
risk free rate iii the u S Government bond rates
and then it adds risk or risk premium to those
rates So if safe bonds are yielding three and a
half percent today the added risk of buying that building
might add another four percent a year in needed returns
Such a cap rate needs to be at least seven
and a half percent for the buying of the building
Teo even make sense many many complications here So for
the sake of clarity let's start with a better definition
of eno iron net operating income You own this building
It has one hundred offices all the same size which
rent for ten grand a year each or rather one
hundred percent aki given See here you have a theoretical
maximum of a million dollars a year in rental income
but today you're only an eighty percent capacity so you're
only getting eight hundred grand and you have expenses Insurance
Fifty grand janitorial service thirty grand heat water gas horning
ran real estate taxes forty five grand and other service
See things like fixing crap and mopping up goop on
the ground when someone bet wrong on the stock market
and uh you know pays their debts a different way
you know twenty five grand So then on eight hundred
grand in revenues the building has one hundred seventy k
year in operating expenses so that's eight hundred minus one
seventy That's six hundred thirty grand in profits And we're
done right No Why Well because almost all of real
estate carrie's dead often lots of debt In any rational
wall street investment you'd include cash and debt on the
balance sheet That part of the valuation methodology here right
But why wouldn't you in real estate Well because the
depth of pockets varies so much among fires some will
pay all cash and then refinanced the optimized tax deductions
on their own Others will just assume debt already in
place on the existing building like they'll just take over
the payments to that bank that's already made alone So
in order to not cloud the value of the operating
cash flows of the building most real estate Investors use
cap rates just to figure out the operating part and
then they add in and back out the dead and
interest on that debt and other investor related costs subsequently
Yeah so yeah that's capitalization rate which in tax written
by a thirteen year old yeah is nearly always zero 00:05:33.705 --> [endTime] percent
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