Underwriting- How has it changed?

There has been a lot of talk lately about what is going on with cap rates. I am constantly asked "Where are cap rates?" and "Where do you think they're heading?" But no one seems to ask "How did we get to this cap rate?"

As most of you know the formula for a cap rate is NOI divided by sale price. It seems simple; if your NOI is $100,000 and the property sells for $1,000,000 then the cap rate is 10%.

Right?

It should be but the big problem is how did we get to $100,000 of NOI. Not all NOIs are created equal.

Is there a 6% management fee included? How about a reserve for capital improvements? What property tax number was used? The current amount or what they will be after the sale. How about insurance? These are all variables on the expense side.

What about income? What length of time was used to determine annual income? How much of the income is from truck rental, late fees, and supple sales? Is the monthly income trending up or down?

The fact is that although the overall cap rates haven't changed that much the underwriting has. Gone are the days of annualizing your best three summer months' income, crediting truck rental income and forgetting to raise property taxes. Today's buyers are much more conscious when determining their NOI. More importantly, the banks have become much more conservative on these items as well. even if we can sell it to the buyer, we may not be able to sell it to the bank.

We've always strived to achieve a standard in our underwriting so that every deal could be accurately compared with other deals on the market but that was not standard for everyone during the care free frenzy of late 2005, 2006, and early 2007. Even today there are inexperience or irreputable brokers who will try to do anything to make a deal look better.

So although the cap rate for your property may have only gone up 50 to 100 basis points, the actual bottom line price to you may be much greater. So throw away the offer or appraisal you received two years ago because it is most likely worthless in today's market.

If you would like us to prepare a free analysis of your property today, so you can accurately determine where your value is in this current market. Give us a call anytime, we are always here to help you.

Next up: When will the market come back?

Where Are Cap Rates Going?

Where are cap rates going? This is the question I get asked most often. The simple answer is up, but not as much as you might think. Although cap rates are going up, how much may depend on the location, age and quality of your property. Right now we have seen true “A” quality properties rise little while “B” properties and risen more substantially and “C” and “D” properties have risen dramatically.

In late 2005, all of 2006 and early 2007 the spread between “A” properties and “C” was almost nonexistent. Today the spread may be as much as 250 to 300 basis points. There are several factors contributing to this but financing is the most prevalent. After the credit meltdown, lenders have become more selective on the deals they will take, buyers have become extremely more selective and occupancies have dipped across markets.

It will be interesting to see what direction cap rates move over the next several months. Although I can’t predict the future, I can see nothing that leads me to believe we will see cap rate compression anytime soon.

If you are sitting on the fence about selling, I would move now.

Look for my post next week about underwriting and how it has changed.

Welcome!

Welcome to The Mele Group of Marcus & Millichap Blog! Though our blog we are going to share important information concerning the self storage industry, current market trends, and the economy. We invite you to leave comments, share information you find and become an active participant. Together, we can create an online space in which we can actively engage in sharing, discussing and analyzing information that could impact the self storage industry.