Cap Rate Variations / Everyone in real estate know how to calculate a cap rate — or do they?

“You miss 100 percent of the shots you never take, and if you think it’s expensive to hire a professional to do the job, wait until you hire an amateur “   

Please check maps if your Land or Commercial Property is in the Opportunity Zone, IF SO CONTACT ME / THIS IS FOR SELLER’S AND BUYER’S.

ARE YOU READY TO SELL OR PURCHASE YOUR INDUSTRIAL / OFFICE OR RETAIL BUILDING OR YOUR  LAND  in Phoenix, Maricopa County and Pinal County, Arizona, please call me.

Also Call me if you need an estimated value of your Property.  Direct : 602-759-1209,  Prefer cell: 520-975-5207,   or email me walterunger@ccim.net.       

 

Commercial real estate professionals live and breathe capitalization rates. Every trade publication, market participant, and third-party report relating to real estate quotes cap rates for various markets and properties. But ask a group of real estate professionals to calculate a specific property’s cap rate and you are likely to get a variety of answers — despite the simplicity of the formula. If cap rates are widely used and easily calculated, then why does everyone come up with a different answer?

This article looks at the underlying reasons for cap rates variations, ranging from different uses by market participants to different methods of cap rate extraction. While CCIMs are trained to extract cap rates in a certain way, not all market professionals use the same criteria. Understanding how such variables can affect the cap rate and the value of a property is just as important as developing — and using — a consistent method of cap rate extraction.

Cap Rate Overview

A cap rate in its simplest form is a return on an investment based on the principle of anticipation. Value is the present worth of future benefits. A cap rate attempts to quantify the risk profile of the future benefits. It is calculated by using a non-complex formula, R=I/V, where I is the net operating income and V is the value of the property. In more complex terms, a cap rate measures a single-period, unleveraged rate of return on a real estate investment. By converting income into value, a cap rate expresses the relationship of one year’s income and value.

A cap rate’s three main components are net income, property value, and the rate of return. If two of the three variables are known, the unknown variable can be extracted through a simple calculation.

Granted, different types of cap rates exist — overall, terminal, equity, mortgage, building, and land — which may cause some confusion among market participants. The overall rate, or OAR, is the cap rate applied to both the land and building and is the most commonly used rate by real estate professionals. A cap rate is essentially a dividend rate, so one could call the mortgage constant a “lender” cap rate and a cash-on-cash an “equity” cap rate. However, in commercial real estate transactions, brokers and investors tend to focus on two cap rates: acquisition and disposition.

Marketplace Misuse?

Common reasons for cap rate variations often come from the income stream and operating expenses used in the rate’s extraction. Failure to consider the likely future income of the property (year one pro forma) does not follow the principal of anticipation. The historical and current operating data is useful when developing a projection of year one data, but should not be used in the extraction of a cap rate when applying it to year one projections. Extracting a cap rate from market data using historical income and applying it to the year one projection of the property being valued will result in an incorrect value opinion.

Real estate is often considered a hedge against inflation due to the ability to increase rents at or above the rate of inflation. In an upward trending market the buyer of a property is expecting next year’s income (year one) to be greater than the trailing year to account for appreciation. Extracting a cap rate from the in-place income (less risk) and applying it to the future income projection (more risk) will overvalue the property.

In addition, the same method of income and expense projections used to extract a cap rate from the market should be used to value a property. Using a different income stream from a comparable property (not stabilized, no third-party management, no replacement reserves, under market operating expenses, and such) will result in a different risk profile of the income stream and corresponding cap rate.

Many market participants do not include replacement reserves as an above-the-line (net income) expense when developing cash flow projections. Replacement reserves for future capital expenditures are market specific. Including or excluding replacement reserves will have an impact on the cap rate extracted from the sales transaction, but not the value of the property. Neither method is incorrect as long as the same method is applied to the property being valued and the sale comparable. If the sale comparable does not include replacement reserves in its pro forma projection, and the subject does include replacement reserves in its year one projection, the market extracted cap rate must be adjusted downward to reflect a riskier income profile of the sales transaction comp when compared to the asset being valued. If no adjustment to the cap rate is made, then the subject will be undervalued due to differing risk profiles. Properties that do not include replacement reserves have increased risk due to the lack of a sinking fund for future capital expenditures.

In other words, the NOI needs to be “clean”: One cannot compare an NOI with deducted reserves above the line with one deducted below the line.

Owner-Managed Properties

Another common misconception concerns third-party management fees. Small properties or ownership entities that have a built-in management company often do not include third-party management fees in their pro forma. Having a third-party management company manage an asset may reduce the operational risk of the property and can result in a lower risk profile of the future income stream. A lower risk profile results in a lower cap rate. Table 1 shows how excluding third-party management fees impact the year one return and risk profile.

As Table 1 reveals, a 7.5 percent cap rate is appropriate if the property pro forma includes expenses for third-party management fees. Based on the projected NOI and market extracted cap rate, a value of $1,666,667 is indicated. If the same property does not include management fees in the pro forma projection, the value of the property is unchanged, with the risk adjusted cap rate increasing to 8.1 percent.

This is why it is necessary for potential buyers to reconstruct NOI to include such items as property management. The increase in the cap rate is to account for increased risk due to the lack of professional third-party management. Additionally, real estate is considered to be a passive investment with the opportunity cost of the owner’s time requiring compensation through a management fee or higher rate of return.

Expense Comparison in Sale Comparables

Comparing the operating expenses used in a sale comparable to extract a cap rate is a good indicator if the cap rate is market driven. A sale comparable that is owner managed and does not include reserves will have below-market expenses on a per unit comparison (percentage of effective gross income, per square foot, per unit, and such). A comparison of the expenses from the sale comparables to industry standards used in the local market will allow the analyst to adjust the extracted cap rate accordingly and then apply the revised cap rate to the property being valued. If a data set of comparable sales indicates a wide range of cap rates, then it is likely that one or more of the sales is not based on market derived income and expenses.

Impact on Property Valuation

Table 2 shows how various income and expense projections can impact the extracted cap rate and the asset’s value indication. For purposes of this analysis, only one variable has been adjusted. In actuality, a sale comparable will often have multiple variables that need to be adjusted in order to accurately extract a cap rate.

The Table 2 example reports a market extracted cap rate that ranges from 5.70 percent, based on the asking price commonly quoted by brokers in third-party surveys for marketing purposes, to 6.48 percent, based on using year one projections. All of the extracted cap rates are correctly calculated. However, the difference in rates is attributed to varying risk profiles of the income stream. Based on the provided example, adjusting just one variable can result in a 13.68 percent difference in value. If additional variables are included, the spread between the cap rates can widen and further magnify the miscalculation.

While there is a simple formula for finding the cap rate, there is no standard method for cap rate extraction. Various markets and market participants apply different income and expenses projections when calculating NOI. However, a standard method for extracting a cap rate from market data is critical to properly value a property. Not all NOIs have the same risk profile. A property that includes third-party management and replacement reserves will have less net income, a lower risk profile due to adequate third-party management, and appropriate funds for future capital expenditures — and result in a lower cap rate. Regardless of the variables included or excluded in the cap rate extraction, if applied consistently to the property being valued, a reliable estimate of value will result.

The Cash Flow Analysis Worksheet used in CCIM classes shows reserves below the NOI line, so CCIMs need to pay careful attention to the components of NOI and make sure that the NOIs of comparable properties are calculated in a consistent manner. A thoughtful CCIM will re-construct NOI to be consistent and will know enough about cap rates in the marketplace and expense ratios, vacancy, and market rents to sense if adjustments are necessary to an advertised NOI.

Daniel Kann, MAI, is director of multifamily valuation for Valbridge Property Advisors/Shaner Appraisals in Overland Park, Kan. Contact him at dkann@valbridge.com. Versions of this article have appeared in Valuation and the Colorado Real Estate Journal.

FROM ME:                                                                                    

Phoenix Commercial Real Estate and Investment Real Estate: Investors and Owner / Users need to really know the market today before making a move in owner user Commercial Properties, Investment Properties and land in Phoenix / Maricopa County, Pinal County / Arizona, as the market has a lot of moving parts today. What is going on socio-economically, what is going on demographically, what is going on with location, with competing businesses, with public policy in general — all of these things affect the quality of selling or purchasing your Commercial Properties, Commercial Investment Properties and Commercial and large tracts of Residential Land  Therefore, you need a broker, a CCIM (Certified Commercial Investment Member) who is a recognized expert in the commercial and investment real estate industry and who understands Commercial Properties and Investment Properties. I am marketing my listings on Costar, Loop-net CCIM, Kasten Long Commercial Group.  I also sold  hundreds millions of dollars’ worth of  Investment Properties / Owner User Properties in Retail, Office Industrial, Multi-family and Land in Arizona and therefore I am working with  brokers, Investors and Developers. I am also a CCIM and through this origination ( www.ccim.com ) I have access to marketing not only in the United States, but also internationalClick here to find out what is a   CCIM:   https://en.wikipedia.org/wiki/CCIM 

PLEASE CALL ME –  Direct : 602-759-1209 , cell: 520-975-5207 or email me walterunger@ccim.net

Please check maps if your Land or Commercial Property is in the Opportunity Zone, IF SO CONTACT ME / THIS IS FOR SELLER’S AND BUYER’S.

WEEKLY LAND CLOSING UPDATE / THROUGH JANUARY 25, 2019 / Phoenix Arizona Metro, Maricopa County, Pinal County.

WEEKLY LAND CLOSING UPDATE / THROUGH JANUARY 18, 2019 / Phoenix Arizona Metro, Maricopa County, Pinal County.

WEEKLY LAND CLOSING UPDATE / THROUGH JANUARY 11, 2019 / Phoenix Arizona Metro, Maricopa County, Pinal County.

WEEKLY LAND CLOSING UPDATE / THROUGH JANUARY 4, 2019 / Phoenix Arizona Metro, Maricopa County, Pinal County.

WEEKLY LAND CLOSING UPDATE / THROUGH DECEMBER 28, 2018 / Phoenix Arizona Metro, Maricopa County, Pinal County.

WEEKLY LAND CLOSING UPDATE / THROUGH DECEMBER 21, 2018 / Phoenix Arizona Metro, Maricopa County, Pinal County.

WEEKLY LAND CLOSING UPDATE / THROUGH DECEMBER 14, 2018 / Phoenix Arizona Metro, Maricopa County, Pinal County.

 

 

WEEKLY INDUSTRIAL CLOSING UPDATE / THROUGH JANUARY 25, 2019 / Phoenix Arizona Metro, Maricopa County, Pinal County.

WEEKLY INDUSTRIAL CLOSING UPDATE / THROUGH JANUARY 18, 2019 / Phoenix Arizona Metro, Maricopa County, Pinal County.

 

 

 

WEEKLY APARTMENT CLOSING UPDATE THROUGH January 25, 2019, Phoenix Arizona Metro.

WEEKLY APARTMENT CLOSING UPDATE THROUGH January 18, 2019, Phoenix Arizona Metro.

WEEKLY APARTMENT CLOSING UPDATE THROUGH January 11, 2019, Phoenix Arizona Metro.

WEEKLY APARTMENT CLOSING UPDATE THROUGH January 4, 2019, Phoenix Arizona Metro.

WEEKLY APARTMENT CLOSING UPDATE THROUGH December 28, 2018, Phoenix Arizona Metro.

WEEKLY APARTMENT CLOSING UPDATE THROUGH December 21, 2018, Phoenix Arizona Metro.

WEEKLY APARTMENT CLOSING UPDATE THROUGH December 14, 2018, Phoenix Arizona Metro.

WEEKLY APARTMENT CLOSING UPDATE THROUGH December 7, 2018, Phoenix Arizona Metro.   

 “You miss 100 percent of the shots you never take, and if you think it’s expensive to hire a professional to do the job, wait until you hire an amateur “  ARE YOU READY TO SELL OR PURCHASE YOUR INDUSTRIAL / OFFICE OR RETAIL BUILDING OR YOUR  LAND  in Phoenix, Maricopa County and Pinal County, Arizona, please call me.  Office: 602-445-4113,  Direct : 602-759-1209 , cell: 520-975-5207 or email me walterunger@ccim.net.  ….  VIEW ALL OF WALTERS LISTINGSLet me know if you are interested in Apartments: CLICK HERE FOR APARTMENTS FOR SALE     

CLICK HERE:  Arizona Opportunity Zones As We Understand /maps. Interested!!! Please contact me.

History of Arizona from  900 BC – 2017 -Timeline.

WHY PHOENIX? AMAZING!!!  POPULATION – IN 1950 THERE WERE 331,700 PEOPLE LIVING IN PHOENIX – “NOW 5 MIL”. – “5TH. BIGGEST CITY IN USA”

PHOENIX TOPS US IN POPULATION GROWTH (MORE THAN LA, NYC) AND WHY THAT’S GOOD FOR THE ECONOMY, BUSINESS

Walter Unger CCIM

Senior Associate Broker

Kasten Long Commercial Group

5110 N 40th Street, Suite 110

Phoenix , AZ 85018

Office: 602-445-4112

Direct: 602-759-1209

Cell:    520-975-5207

Fax:       602-865-7461

walterunger@ccim.net

www.Walter-Unger.com

www.KLCommercialGroup.com

View All My Listings

What is a CCIM.

 

8 Reasons You Should Invest in Land

History of Arizona from  900 BC – 2017 -Timeline.

 

WHY PHOENIX? AMAZING!!!  POPULATION IN 1950 – 350 K PEOPLE; “NOW 5 MIL”. – “5TH. BIGGEST CITY IN USA”

PHOENIX TOPS US IN POPULATION GROWTH (MORE THAN LA, NYC) AND WHY THAT’S GOOD FOR THE ECONOMY, BUSINESS

CLICK HERE:  VERY COST EFFECTIVE SPONSORSHIPS AVAILABLE / South Scottsdale: Where the World Comes to Play and Innovative Companies Excel”

 

DOT – LOOP 202 / SOUTH MOUNTAIN FREEWAY / PHOENIX AZ – UNDER CONSTRUCTION

ARIZONA FACTS – YEAR 1848 TO 2013

VIEW ALL OF WALTERS LISTINGS

What is a CCIM.

CLICK HERE TO VIEW MY WEBSITE

  • DEMOGRAPHIC FACTS ABOUT MARICOPA COUNTY:
  • The average age of the population is 34 years old.
  • The health cost index score in this area is 102.1. (100 = national average)
  • Here are some of the distributions of commute times for the area: <15 min (22.7%), 15-29 min (36.8%), 30-44 min (25.1%), 45-59 min (8.6%), >60 min (6.8%).

PHOENIX PROJECTED AS NUMBER ONE US HOUSING MARKET FOR 2017

LIST OF ECONOMIC DEVELOPMENT PROJECTS IN PINAL COUNTY, REVISED 2-14-17

Reasons to Consider me for Commercial Referrals – I have the Knowledge and Experience                                                                                                                         

Click here to View My Listings and Profile

Click here to find out what is a CCIM:

Click here to view my website:

Click her to join my mailing list :      

Walter Unger CCIM –  walterunger@ccim.net   – 1-520-975-5207  –  http://walter-unger.com

2016 Official Arizona Visitors Guide

Visit Arizona

Why Phoenix?  This is a very interesting article, you should read it, amazing, there were only 350 K people living in Phoenix in 1950

Timeline of Phoenix, Arizona history

Phoenix, Arizona

Facts of Arizona – year 1848 to 2013

Feel free to contact Walter regarding any of these stories, the current market, distressed commercial real estate opportunities and needs, your property or your Investment Needs for Comercial Properties in Phoenix, Tucson, Arizona.

Walter Unger CCIM

Senior Associate Broker

Kasten Long Commercial Group

5110 N 40th Street, Suite 110

Phoenix , AZ 85018

Office: 602-445-4112

Direct: 602-759-1209

Cell:    520-975-5207

Fax:       602-865-7461

walterunger@ccim.net

www.Walter-Unger.com

www.KLCommercialGroup.com

View All My Listings

What is a CCIM.

Check out my professional profile and connect with me on LinkedIn.

Follow me on LinkedIn

Follow me on Facebook

Follow me on Twitter

 Kasten Long Commercial Group tracks all advertised apartment communities, including those advertised by other brokerages.  The interactive map  shows the location of each community (10+ units) and each location is color coded by the size (number of total units). 

 Walter Unger CCIM, CCSS, CCLS

I am a successful Commercial / Investment Real Estate Broker in Arizona now for 20 years.  If you have any questions about Commercial / Investment Properties in Phoenix or Commercial /  Investment Properties in Arizona,  I will gladly sit down with you and share my expertise and my professional opinion with you. I am also in this to make money therefore it will be a win-win situation for all of us. 

Please reply by e-mail walterunger@ccim.net or call me on my cell 520-975-5207

www.Walter-Unger.com

 

Are you ready to sell or purchase your Land or Commercial Building in Phoenix, Scottsdale, Maricopa County and Pinal County, Arizona, please call me.

Join My Mailing List

What is a CCIM?

Reasons to Consider me for Commercial Referrals

Delivering the New Standard of Excellence in Commercial Real Estate 

  •  
  • Commercial Real Estate Scottsdale
  • Commercial Real Estate Phoenix
  • Commercial Real Estate Arizona
  • Commercial Investment Properties Phoenix
  • Commercial Investment Properties Scottsdale
  • Commercial Investment Properties Arizona
  • Land Specialist Arizona
  • Arizona Land Specialist
  • Land Specialist Phoenix
  • Phoenix Land Specialist
  • Land For Sale Phoenix
  • Land for sale Arizona
  • Commercial Properties For Sale Phoenix
  • Commercial Real Estate Sales Phoenix
  • Commercial Properties Phoenix
  • Commercial Properties Arizona
  • Commercial Land Specialist Phoenix
  • Commercial Land Phoenix
  • Multifamily land Phoenix
  • Retail Land Phoenix
  • Industrial Land Phoenix
  • Land Commercial Phoenix
  • Land Retail Phoenix
  • Land Industrial Phoenix
  • Land Multifamily Phoenix
  • Industrial Land for sale Phoenix
  • Land Industrial
  • P
  • Investment Real Estate

 

Disclaimer of Liability

The information in this blog-newsletter is for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this e-newsletter are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided “as is,” with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.