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?
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3 comments:
Mike,
I agree. The rules to the game have changed. Underwriting has become more conservative and the cap rates have increased. You make some great points about how the banks are looking at income, as well as, how they are adjusting for expenses. Keep up the good work. I really enjoy reading your blogs.
Jim
Mike, I have noticed in the flyers and postcards that you have sent recently that pricing has changed dramatically and I am seeing deals sell at or near 10% CAP rates. Am I to assume that all deals are trading at those high CAP rates? My property is leased up to about 60% and has stopped. I would like to consider selling, but are deals like that even worth considering for the market? Again, this blog is a great idea and I look foward to your updates.
The days of 6-7% cap rates are well gone; however, not all properties are selling at 10%+ cap rates just yet. The trading cap rate will depend on several factors but are currently ranging between 8% to 11%. Quality of asset, quality of the location (exposure & demographics), current occupancy levels, and rent collections trends all affect the cap rate. When it comes to your property, at 60% occupied, we can sell your property but it will be strictly on current numbers. At this point, investors and lenders are not crediting for pro formas; therefore, your NOI (correctly underwritten) divided by the accurate cap rate will allow us to obtain the current value.
9%- 10%+ cap rates will sooner or later become the norm once again. There were the norm for many years and the current trends with the possible rise in interest rate sand lead me to believe that we will go back to the days prior the year 2004. Investors looking at self storage facilities are looking more and more at their exposure and volatility as a business, and as a business they want a higher return that accounts for all possible pitfalls of operating a self storage facility.
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