Cap rate question - Posted by john

Posted by ray@lcorn on August 08, 2006 at 14:54:26:

john,

For NNN single-tenant properties, the end game will be directly affected by the prevalent cap rate at the time based on tenant credit quality, lease quality, finance terms, required investor return, and then the dirt quality, in that order. For more about triple-net deals, see http://www.real-estate-online.com/articles/art-286.html

So yes, the price will be comparable to properties with similar tenant quality and remaining lease term. If the property happens to be very well-located, the residual value of the dirt may be greater than the value of a building with an expired lease.

ray

Cap rate question - Posted by john

Posted by john on August 07, 2006 at 20:28:07:

I am looking at a property with a true current cap rate of 6%. This means that if i bought the property with cash today, my annual rate of return from the cashflow is 6%. The lease is for 20 years Triple Net with a personal guarantee. At the end of 20 years when the loan is paid off, my cap rate will be about 10% based on the amount I bought the property for. If I sell the property at a higher price in 20 years, the cap rate will obviously be lower than 10%. The question is how important is the cap rate to a buyer when purchasing a property?
Should I be buying a property at such a low cap rate of 6% now? Let me know your thoughts. Thanks.

Re: Cap rate question - Posted by Guy M. Blasi, CPM

Posted by Guy M. Blasi, CPM on August 07, 2006 at 21:18:49:

If you can find a true cap rate of six percent, good for you if it’s the type of property you want to own and had a good location. Rule of thumb, the bankers & mortgage companies want to see the highest cap possible, but the buyer should find the lowest cap possible. The ever-elusive cap rate these days are ususally backed-into by the seller or the seller’s broker. In reality, your “end game” in five years has only a small bit of relevance with respect to a cap rate five years from now. The cap rate is the desired rate of return for an investor. Five years from now, what really matters is what the state of your local economy in the micro and the state of the national and world economy in the macro. Once you get the building, make sure it runs like a fine machine. Make sure it has good tenants and favorable leases and provide the best in property management. Best of luck.

Guy M. Blasi, CPM
cpm14804@aol.com

Re: Cap rate question - Posted by ray@lcorn

Posted by ray@lcorn on August 08, 2006 at 14:50:32:

Guy,

There is just no gentle way to put this… you’re wrong on almost every point in your post.

Cap rates are inverse to price, meaning the lower the cap rate the higher the price, and consequently the lower the return to the investor. Buyer seek higher caps, sellers lower.

Lenders care about cap rate only tangentially. Their focus is on lease quality, debt coverage ratio, and the credit and cash of the borrower. A higher cap reflects a lower price, hence the lender would be able to safely underwrite more debt, and while more debt increases return, it decreases cash flow.

You are correct in that most sellers and brokers back into the asking cap rate. The cure is to develop your own rate based on specific minimum return requirements and loan terms. For more on that see this article: http://www.real-estate-online.com/articles/art-216.html

For NNN single-tenant properties, the end game will be directly affected by the prevalent cap rate at the time based on tenant credit quality, lease quality, finance terms, required investor return, and then the dirt quality, in that order. For more about triple-net deals, see http://www.real-estate-online.com/articles/art-286.html

ray

Re: Cap rate question - Posted by john

Posted by john on August 08, 2006 at 08:10:20:

Does this mean that when I sell the place someday, my price has to fall in line with a competitive cap rate with a comparable property?