SS158: What is Weighted Average Cost of Capital

SS158 What is Weighted Average Cost of Capital

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Talking Points:

  • The weighted average cost of capital is the average cost of capital from all sources used to finance a property, including debt and equity.
  • The weighted average cost of capital is a hurdle rate that investors need to exceed for a deal to be profitable.
  • For example, if a real estate investment firm had a lender that would lend 60% loan-to-value on a property for 5% and also had equity investors who would loan the remaining 40% of the purchase for 20% – the investment’s weighted average cost of capital would be 11%.
    • This real estate investor must exceed an 11% return on investment to make any money.
    • The debt lender is in the first position and is lending only 60% of the purchase price; a very conservative position, hence the 5% rate. The equity investors are in a much riskier position and are second in line to be paid, so they have a 20% equity cost.
  • The weighted average cost of capital is essential because it determines, in a single number, what the real estate investment firm’s actual cost of capital will be. It simplifies the deal analysis process because any deals with returns that are not considerably higher than the weighted average cost of capital might not be worth pursuing.
    • Most real estate investment companies operate mainly on borrowed funds, making this metric extremely important.
    • More seasoned real estate operators will most likely have a lower weighted average cost of capital when compared to new operators.
  • The weighted average cost of capital is not just for large and smaller investors. If an investor wants to purchase an investment property for $100k, their bank will lend them $75,000 at 7%. The investor can borrow the remaining $25k at 10% in the form of a home equity loan; the weighted average cost of capital for this investor is 7.75%.
    • The simple calculation is to multiply 75% x 7% and then multiply 25% x 10%; then add them up, and you get your weighted average cost of capital or 7.75% in this example.
    • The investor now knows that their total cost of capital is 7.75%, and they will need to find a deal that will generate a return higher than this.
  • Knowing the weighted average cost of capital will make you a better-informed investor, and you will now be able to filter out deals quicker because you know your “hurdle” rate.

Transcript:

Charles:
Welcome to Strategy Saturday; I’m Charles Carillo and today we’re going to be discussing what is weighted average cost of capital.

Charles:
Have you always wanted to invest in real estate, but didn’t have the time, didn’t know where to find the deals, couldn’t get the funding and didn’t want tenants calling you. Since 2006, I’ve been buying income producing properties and great locations that provide us with consistent passive income. While we wait for appreciation in the future and take advantage of tax laws while we’re waiting and unlike your financial advisor, we invest alongside our investors in every property we purchase. Check out to investwithharborside.com. If you like the idea of investing real estate, if you like the idea of passive income partner with us at investwithharborside.com, that’s investwithharborside.com.

Charles:
The weighted average cost to capital is the average cost to capital from all sources used to finance a property, including debt and equity.

Charles:
The weighted average cost to capital is a hurdle rate that an investors need to exceed for a deal to be profitable. For example, if a real estate investment firm had a lender that would lend 60% loan to value on a property at a rate of 5%, and also had an equity investors who would loan the remaining 40% of the purchase for a rate of 20%, the investors now have a weighted average cost to capital at 11%. Now, this real estate investor must exceed 11% return on investment to make any money. The debt lender is in the first position and is lending only 60% of the purchase price, a very conservative position. Hence, they’re only getting paid a 5% rate. Now, the equity investors are in a much riskier position in our second in line to be paid, so they have a 20% equity cost. Now, the weighted average cost of capital is essential because it determines in a single number what the real estate investment firm’s actual cost of capital will be.

Charles:
It simplifies the deal analysis process getting any deals that with returns that are not considerably higher than the weighted average cost to capital might not be worth pursuing. Most real estate investment companies operate mainly on borrowed funds making this metric extremely important. More seasoned real estate operators will most likely have a lower weighted average cost to capital when compared to newer operators. Now, the weighted average cost to capital is not just for large investors, but also for smaller ones. Now, if an investor wants to purchase an investment property for a hundred thousand dollars and they’re going to finance it by using, getting a loan from their bank while also getting a home equity loan, and their bank will lend them, say, 75% or $75,000 at 7%, the investor can then borrow the remaining 25% or $25,000 at 10% in the form of a home equity loan.

Charles:
Now, the weighted average cost of capital for this investor in this situation is 7.75%. Now, the simple calculation is really you multiply, so 75% of the deal was at 7%, so you take 75% times 7%, and then you multiply, you had 25% of the deal at 10%, so now you take 25%, multiply by 10%, and then you add ’em together. And when you get your average cost to capital or 7.75% in this example, the investor knows exactly what their total cost of capital is, and they’ll need to find a deal that will generate a return higher than this. Now, knowing the average cost of capital will make you a better informed investor and you will now be able to filter out deals quicker because you know your own hurdle rate. So I hope you enjoyed. Please remember, rate, review, subscribe, submit comments and potential show topics at globalinvestorspodcast.com. If you’re interested in actively investing in real estate, please check out our courses and mentor and programs at syndicationsuperstars.com. That is syndication superstars com. Look forward to two more episodes next week. See you then.

Announcer:
Nothing in this episode should be considered specific, personal or professional advice. Any investment opportunities mentioned on this podcast are limited to accredited investors. Any investments will only be made with proper disclosure, subscription documentation, and are subject to all applicable laws. Please consult an appropriate tax legal, real estate, financial or business professional for individualized advice. Opinions of guests are their own information is not guaranteed. All investment strategies have the potential for profit or loss. The host is operating on behalf of Syndication Superstar, LLC, exclusively.

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