When you hear the phrase "market cap," it's almost impossible not to think about a company's value on the stock market. However, did you know that it can also be used to help you evaluate real estate stocks? If you've ever wondered, "What is a market cap in real estate?" keep reading. We'll explain to you what market cap means in real estate and how using this metric can help you add value to your portfolio.
What is a market cap in real estate?
Broadly, the term "market capitalization," or "market cap," applies to the stock market. It's a metric that allows investors to valuate a company based on its public perception. A company's market cap represents the total value of the company's stock and it is calculated by multiplying the number of the company's outstanding shares by the current share price. Generally, the higher the resulting number is, the more valuable the company is thought to be.
As a valuation metric, market capitalization can be used to evaluate all sorts of stocks, including real estate stocks.
Finding a real estate company's market cap: A simplified example
Stock price: $30
Company's outstanding shares: 50 million
Market cap: $30 x 50 million = $1.5 billion
What are the different market cap types?
It's worth noting that while it's very simple to figure out a real estate company's market cap on your own, you generally won't have to do so. Most publicly traded companies prominently list their market valuation.
Instead, a better idea is to know how the company is classified based on its total market cap. In all, there are five different categories of market cap that a company can fall into based on its total asset value.
- Mega-cap stocks: Some of the world's largest companies are considered mega cap stocks. They have an asset value of more than $200 billion dollars.
- Large-cap stocks: Large cap companies have a market capitalization range of $10 billion dollars to $200 billion dollars.
- Mid-cap stocks: A mid-cap company will have a total market cap that falls between $2 billion dollars and $10 billion dollars.
- Small-cap stocks: Small-cap companies have a total market value between $300 million dollars in $2 billion dollars.
- Micro-cap stocks: Lastly, micro-cap companies have a market cap of less than $300 million dollars.
Using market cap as a metric to evaluate real estate stocks
At its core, market capitalization can be used to help an investor shave their investment strategy. Put simply, a company's size helps shape the behavior of its stock. When you're evaluating different real estate stocks in order to see which one to add to your portfolio, looking at the company's market capitalization can help give you a sense of what type of growth and returns you can expect.
Large market caps indicate steady dividends
Generally speaking, large-cap companies are good for providing steady returns since they tend to generate more cash than they need to keep up with their business operations. That excess is often forwarded along to the investor in the form of healthy dividends.
However, large-cap companies also tend to offer less in overall price growth. Typically, a larger company has already established itself as a leader in the real estate industry and has weathered market downturns successfully. As a result of that experience, these stocks are thought to be less risky than smaller operations.
Small market caps signify growth potential and increased risk
Small-cap companies are usually smaller companies and startups, which means small-cap stock is usually classified as a growth stock. While these companies offer the potential for above-average returns, there's also the risk of loss. There's a good chance that a small-cap company may not have weathered a downturn in the real estate market as yet, so it will not have as much of a proven track record of surviving through tough times.
Mid-size market caps can go either way
Truthfully, it's hard to make a generalization about what type of behavior to expect from mid-cap stocks. In some cases, these companies are still on a growth trajectory. Thus far, they've done fairly well at establishing their portion of the market share and can offer more stability to investors than a smaller company. However, in order to be able to offer similar dividends to their larger competitors, they need to find a way to continue to raise their current market price.
In other cases, a mid-cap stock could be a former large-cap company that has lived on past its heyday. Otherwise, the company may be doing well in a specific corner of the real estate industry and it's not really looking to grow beyond its niche. In either case, you'll need to do some research aside from the company's share price and total asset value in order to decide whether or not to invest.
The bottom line
If you're considering adding real estate stocks to your portfolio, looking at an individual stock's market cap can be a simple way to forecast the type of returns you'll see. That said, keep in mind that no one metric will ever give you a full picture of any investment. In order to decide whether or not you want to invest in a particular REIT or real estate fund, you should also look at a host of other valuation metrics.
In addition, keep in mind that diversification is the key to any balanced portfolio. Where real estate stocks are concerned, it's a good idea not to have too many small-cap companies in your portfolio at one time. However, unless you're a particularly risk-averse investor, having all large-cap companies will likely not give you the amount of growth you're ultimately after. When in doubt, having a mix of market-cap sizes in your portfolio is likely going to be your best bet.