What Is the Reversion Cap Rate?

Real estate investments are trendy and are also based on figures and numbers. Investors use many metrics and tools to know the potential gains and losses they can incur from an investment. If you have just started with real estate investments, then 'cap rate' is a common term. 

The reversion cap rate is one such metric or tool used by real estate investors to know about the prospects of the property deal. This tool is different from the capitalization rate that suggests the potential return on investment at the beginning of the agreement. In contrast, the reversion rate tells the asset's profitability at the end of the deal. The current cap rate is the price at which similar properties are selling in the market. 

One can use the reversionary cost of the property at the time of underwriting the project's exit value. It gives the investor a safer passage to exit the investment. In most cases, this is higher than the cap rate by a certain percentage. 

As a Metric

As a new real estate investor, a person needs to know the capitalization rate as well as the reversion rate of the property. People will make better decisions regarding their real estate investments once they know both these rates. The reversion cap rate of a property is expected at the end of a project. Some people commonly refer to this metric as the exit or terminal cost. 

To calculate the property value, you can divide the expected net operating income with the reversion rate and then get the discount. This is handy because sometimes the market can be too dynamic. For example,  the interest cost on property keeps on changing every day. 

Why Is It Significant? 

You may think that the capitalization figure is the sole important metric for real estate investments. However, this is not true, as the reversion will give clues about your investment that can be used in the long run. 

Ideally, it would help if you looked for the reversionary cost to be 0.5% higher than the entry cap cost of the property. This means that both the buying and selling parties assume the property cost will go down as the market dips. The basic plan of using the reversion figure is to undersell the project or the property but over deliver at the time of project completion.

Underselling the project serves as a contingency plan for you if the project does not end well. The difference between these two rates might be meager, but it can still significantly impact the deal. 

The price of an investment depends on the risk profile of that asset. As an investor, it is up to you to analyze the risk class of investment. To explore the risk class, you can look at previous cap rates for similar properties in that region. Ideally, it would help if you considered an 8% exit rate that is good enough to exit the project and cash in on the returns.  Through such techniques, you'll get an idea of the property's resale value. 

Final Thoughts

The reversionary figure is the capitalization amount at the end of a project, unlike the traditional figure. The conventional amount gives information while the project is still going on. It is considered a good investment if your reversion cost is higher than your entry rate. This is because both parties thought the market would go down at project completion.