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. FOR OVER 20 YEARS, I HAVE WORKED EXTENSIVELY WITH OWNERS AND BUYERS IN LAND, COMMERCIAL AND INVESTMENT REAL ESTATE IN PHOENIX, TUCSON AND THROUGHOUT ARIZONA. PLEASE LET ME KNOW HOW I CAN HELP YOU. Call me if you want to sell your property and need an estimated value. Phone / Prefer cell: 520-975-5207
Office: 480-948-5554 or email me walterunger@ccim.net. – What is a CCIM.
In Business and in Life you don’t get what you deserve, you get what you Negotiate.
contact me if you want the me to get you the value of your property.
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Cap Rate Variations – Everyone in real estate knows how to calculate a cap rate — or do they?
BONUS VIDEO AT THE END
by Daniel Kann – CIRE Magazine » CIRE Archives » Mar.Apr.15
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.
Understanding the Current Real Estate Cap Rates
Cap Rate = Net Operating Income / Property Price
For example:
Purchase Price: $500,000
Income Per Month: $15,000
Expenses Per Year: $100,000
NOI = Annual Income – Annual Expenses or (12 x $15,000) – ($100,000) or $80,000
Cap Rate = NOI / Property Price or $80,000 / $500,000 or 16%
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.
1
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.
2
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.
SEE IT ALL:
BONUS
Alec Pacella, CCIM, explains cap rates in this brief video. Check it out:
CLICK HERE: Real Estate 101 – “Cap Rate”
https://www.youtube.com/watch?v=djwpXaPKRBo
FROM ME: FOR OVER 20 YEARS, I HAVE WORKED EXTENSIVELY WITH OWNERS AND BUYERS IN LAND, COMMERCIAL AND INVESTMENT REAL ESTATE IN PHOENIX, TUCSON AND THROUGHOUT ARIZONA. Now is the time, if you are thinking of selling or purchasing your Land or Commercial Building in Phoenix, Scottsdale, Maricopa County, Pinal County, Arizona / Office / Retail / Industrial / Multi-family / please call me on my cell 520-975-5207 or e-mail me walterunger@ccim.net. Investors and Owner / Users need to really know the market today before making a move. The market has a lot of moving parts. 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 your needs. I am marketing my listings on Costar, Loop-net, CCIM, CREXi, Catylist, and various other web sites. 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 international
What is a CCIM. In Business and in Life you don’t get what you deserve, you get what you Negotiate.
Are you ready to sell or purchase your Land or Commercial Building in Phoenix, Scottsdale, Maricopa County and Pinal County, Arizona, please call me?
contact me if you want the me to get you the value of your property.
CCIM DEAL MAKERS FALL 2020 THE BIGGEST DEAL WALTER UNGER, CCIM, WITH WEST USA COMMERCIAL DIVISION IN PHOENIX REPRESENTED GCG HOLDINGS LLC IN ITS $29.43 MILLION SALE OF GOLD CANYON GOLF RESORT AND SPA IN GOLD CANYON, ARIZ., TO GOLD CANYON MJ LLC.
CCIM DEAL MAKERS FALL 2020 THE BIGGEST DEAL / WALTER UNGER, CCIM, WITH WEST USA COMMERCIAL DIVISION IN PHOENIX REPRESENTED GCG HOLDINGS LLC IN ITS $29.43 MILLION SALE OF GOLD CANYON GOLF RESORT TO GOLD CANYON MJ LLC.
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PRESS RELEASE: Gold Canyon resort sells for $29.4M. Walter Unger CCIM from West USA Commercial Division Brokered the Transaction.
http://walter-unger.com/gold-canyon-resort-sells-for-29-4m/
Walter Unger CCIM
Associate Broker
West USA Commercial Division
7077 E MARILYN RD.
Suite 200, Building 4.
Scottsdale AZ, 85254
Phone: 480-948-5554
Cell: 520-975-5207
History of Arizona from 900 BC – 2017 -Timeline.
History of Arizona from 900 BC – 2017 -Timeline.
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”
Walter Unger CCIM – walterunger@ccim.net – 1-520-975-5207 – http://walter-unger.com
Timeline of Phoenix, Arizona history
Facts of Arizona – year 1848 to 2013
CLICK HERE: Arizona Opportunity Zones As We Understand /maps. Interested!!! Please contact me.
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
Associate Broker
West USA Commercial Division
7077 E MARILYN RD.
Suite 200, Building 4.
Scottsdale AZ, 85254
Phone: 480-948-5554
Cell: 520-975-5207
FOR OVER 20 YEARS, I HAVE WORKED EXTENSIVELY WITH OWNERS AND BUYERS IN LAND, COMMERCIAL AND INVESTMENT REAL ESTATE IN PHOENIX, TUCSON AND THROUGHOUT ARIZONA. PLEASE LET ME KNOW HOW I CAN HELP YOU PLEASE CALL ME
CLICK HERE TO VIEW ALL MY LISTINGS.
Also Call me if you need an estimated value of your Property.
Call me if you want to see a map with what is in the Construction Pipeline for Apartments.
Prefer cell: 520-975-5207, or email me walterunger@ccim.net. CLICK HERE TO VIEW ALL MY LISTINGS.
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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.
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