High cap rates and low interest rates make now a great time to buy

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cap rateWith all the hype about how home ownership is dead and real estate is no longer a good investment, it's useful to look at some numbers.

Instead of all the headlines and hysteria, numbers can tell us -- with some objectivity -- whether real estate is attractively priced.

Today's Wall Street Journal reports (subscription required) that "The average cap rate for office properties in central business districts jumped to 8.8% in December from 8.56% in November. The December number was the highest rate for that category since May 2003. Meanwhile, average cap rates for apartment buildings was 7.36% in December, up from 7.09% in November."

What exactly is a cap rate? Glad you asked: think of it as the yield. You take the annual net operating income (the rental income the property would produce minus taxes and maintenance expenses) and divide it by the market value of the property.

So if I have a a house that rents for $1,100 per month and costs me $250 per month in operating expenses for a net operating income of $850 and the property is worth $150,000, my cap rate is 6.8%. The higher the cap rate, the more attractive the investment.

The rise in cap rates tell us that the market values of properties are falling faster than the stream of cash flows those properties provide as rentals -- and that's before taking into account the historically low interest rates that are making real estate so attractive as a long-term income-oriented investment right now.

Don't fall for the hype and doomsday predictions: mathematically, real estate is looking awfully good right now.
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