In recent years, residential investors have sought out beachfront product on Barbados largely with the intention of holding for a period and eventually cashing in the capital gain on resale. By and large the same can be said for off-beach residential investors, whether in a local residential neighbourhood or a branded or themed development. Once running costs and some element of debt service were looked after, the anticipation of double-digit appreciation took precedence over the cash or operating return. With a focus on the overall yield as opposed to the cash return in isolation, an investor was generally content with the performance of this asset class. As the market continues to change and as some segments experience slowing in absorption (and in some cases oversupply), many residential investors are looking more carefully at the cash or operational side of the equation.
Capitalisation (Cap) rates for residential property vary widely subject to the usual parameters. Data on transactional cap rates is not readily available, and in fact it is not uncommon to find appraisers applying a generic rate or a weighted average cost basis to residential property. This generally results in an application of a significantly higher cap rate (usually around 9%) and therefore a considerably lower indicated value. The appraiser is then likely to apply little or no weighting to this approach in arriving at their overall conclusion of market value.
Another common misperception when analysing transactional cap rates is the ratio of actual expenses to gross rents. While expenses are typically underestimated, they are averaging 30% of gross rents subject to the value of the property. Expense ratios generally also increase with property value; by and large a function of the progressive nature of the land tax system.
The following table illustrates transactional cap rates for twenty-five residential properties within various price segments. All of the properties are single-family dwellings and were either sold or contracted for sale within the previous twelve months. Rates are calculated on the basis of stabilised net operating income for actual sale transactions.
While there are some anomalies in the data, the overall average cap rate for the set of properties is 3.42%. Again this rate does not reflect an average annualised yield for the subject properties, rather the annualised net operating income an investor can expect to generate (after costs but before taxes and debt service). Perhaps the most obvious conclusion one can draw from the graph is the inverse relationship between residential property prices and cap rates. The average rate for properties with price points less than one million dollars is 4.55% – well above the overall average and significantly above the average for properties above two million dollars (2.3%). Considering this basis in isolation, an investor would realize a better return purchasing four properties in the half-million dollar range than a single two million dollar property. He would have less exposure to vacancies, greater flexibility, and be likely to realise comparable appreciation given the historically strong demand in that price segment.
Cap rates are also a useful measure of market trends over time. As a rule of thumb, in a real estate market where net operating incomes are increasing and cap rates are declining over time for a given type of investment property, values will be generally increasing. If net operating incomes are decreasing and cap rates are increasing over time, property values will be generally declining. To date we haven’t seen much of the latter, however as the market continues to change we will continue to report our findings.
Hayden Hutton Director – Brokerage Services, Terra Caribbean