Calculating Cap Rates using Band of Investments Method
The document explains how to calculate an imputed capitalization rate using the Band of Investments Method. This method determines the overall rate of return on a property by combining the weighted returns of both debt and equity in the capital stack. The calculations involve entering assumptions such as mortgage index rates, loan-to-value ratios, mortgage spread, amortization period, number of payments per year, equity dividend rate, and net operating income.
The process includes calculating the equity ratio, periodic and annual mortgage constants, weighted returns on equity and debt, and ultimately the total imputed cap rate. The method uses various mortgage indices like SOFR, Treasury yields, and the Prime Rate, all of which can affect the mortgage rate and thus the cap rate.
An example is provided to show how changes in assumptions impact the final valuation. The method is useful for comparing property valuations under different financing structures and in different market conditions. It also helps assess how changes in mortgage rates or investor return expectations affect property values over time. This approach is particularly valuable for dynamic market environments, allowing investors to simulate scenarios and make informed decisions.