I’d be interested in opinions as to what cap rate you consider a fair market return for any particular property type(s) you look at. I’m talking buy and hold.
Let’s assume the rate is realistic, using real world income, vacancy allowances, expenses, etc.
I’m looking at a lot of semi-armchair type scenarios like Class B office buildings, med buildings, strip malls, and such. For the most part, the cap rates are low, and get even worse when you “real world” them.
As an armchair investor, I like to see probably 9-10% for a med building in a good location, 10+ for a good office building, and more than that for a strip mall. I have no opinion on apt buildings and the like. For one that will stand the test of time, probably 10% with property management if it was truly armchair.
I’m not a fan of turnaround situations. I just don’t have the interest and experience at them. Let someone else do those. When you are looking at a solid, fully-rented building with decent tenants, you are paying for that value.
At those numbers, it has to be a quality building in a favorable long term location. Obviously I’d like to do better, but I think those would be good. And they are hard to find at those rates and criteria.
Whatever cap rate you need is fair. You set the cap rate with your purchase price. If you want a 10% cap and the seller’s price only works out to a 6% cap, then you have to negotiate the price down to raise the cap rate to whatever is acceptable to you.
Well at least you realize that the CAP rate that the listing agent is claiming is a bunch of hooey, and you have to figure your own CAP.
The only use I can see for a CAP rate is to compare two really dissimilar investments before you get in there and dig out the information you need.
Here’s the problem with using any sort of formula to figure the value of real estate: The formula gives you a brief figure that is useful for a very short period of time. It may not even still apply tomorrow.
Real estate is never static. It is a very dynamic investment. So a tiny little glimpse of what it is worth today doesn’t really tell you much about whether or not a property is a good purchase.
Use you cap rate to decide if you are interested, but then you have to consider the stability of the tenants, the growth patterns of the city, the supply of available commercial land, The age of the buildings (commercial has a life span), the economic health of the town, plans for road developement, and whether or not Wal-mart has announced that they are going to be building a super center.
You also have to look at the surrounding area and whether it is going up in value or down.
How much time is left on the leases are going to affect the value of your purchase. The type of care your tenant gives the buildings is going to have an efect on the value. Even the style of the buildings is going to have an effect on the value.
Then you have to check with the police and the fire marshall to see what sort of information they have about your potential purchase. Because they might have something to say that will affect the value of the property.
If you are going to invest in commercial, you need to be really looking out into the future and thinking long term.
In Philadelphia area they are reported to be 6.0 to 10%.
I see WALGREENS,CVS (AAA rated) at 6.0 to 7.0 cap
I see mom and pop building and small strips centers and apartments listed at 7.0 to 9.0 cap.
Goto LOOPNET.COM and look at properties for sale, in your area and see the CAP RATES they are advertising. Beware of what they “say”. I see one listed at 10cap that is 0% occupied (they base it of the last tenenat that was there). I see another listed at 6 CAP but that is based on NOI because they say it is turnkey. After discussions, I learned owner(you) would do all Maintenance(snow/grass/repairs/free supplies) and 0 Vacancy/credit loss/advertising/legal.
These expenses HAVETO be subtracted from Gross Income and when you do, it is a -0.6 Cap rate. Not a good deal. The point is you need to calculate and verify their NOI calculation.
Be careful about any stated cap rate from a broker. Most brokers have no idea how to develop a cap rate. You need to develop an investment cap rate that meets your goals for the investment and that cap rate may or may not be what the market is doing.