Cap Rate Decompression
This blogging thing can be quite fun..
Finally an article that caught my attention, perusing this active rain thing. Good stuff from blogger Jim Randle I wanted to reblog. In regrads to Cap rate Compression. I had been involved with many assets deem Trophy property, an asset class which Assumes risk adverse factors based on Superior locations,view or the underlying unimproved as having a > highest and best use.
(which means pretty much throw your money away for ego value).
Sub 4 and 5 caps and IRR less than 8/9 after projected 5 of 7 yr holds. Because of there Manhattan locations. If assumable debt was not in place at correct leverage amount your BTCF after DS could be -2. For the uber wealthy looking for such ego driven caps it still doesn't make sense. Even though many intend to stay longer than 10 yrs. But with office rates low, occupancy up, Hedge funds trying to sublet space at a loss at the 5th ave location or view over the Hudson.
well you know the rest.
Same situation here where i live and sell in Naples, FL. We had Manhattan cap rates. For hick town strip center designs. again fueled by the uber wealthy locations who place value in what they want even i it doesnt make sense.
Cheers,
Mike Rivera
Investment Real Estate Analyst
StarCapitalGroup
Naples Fl
239-770-6257
Fax 239-775-2066
http://www.starcapitalgroup.blogspot.com
www.condokmanagement.blogspot.com
Mike Rivera & Associates,LLC
Repost from 1-12-09
It seems like just a year ago I was speaking with a buddy of mine who specialized in investment sales of large real estate properties. As I was performing due diligence on some of these properties for an acquisition group I represented, I was very familiar with the numbers. When I heard the seller's asking price, and subsequently was stunned by the sales price, I asked (demanded?) my buddy for an explanation.
"Jim, you just don't get it ... it's cap rate compression."
Let me back up a bit for those who are not familiar with "cap" rates. The cap rate, short for capitalization rate, is the return that a real estate investor will accept on an unleveraged purchase (no debt). Since 90% of investors use debt to make an acquisition, the cap rate is just a measure - a scoring system of sorts.
By way of example, if an office building is in a top location with lots of room for potential rent increases, a buyer will presumably accept a lower rate of return on his cash than would a buyer of a similar building in a B location with less upside. In other words, the buyer of the primo building will purchase with a lower cap rate. In order to determine purchase price, the net operating income of a building is divided by the cap rate. So, a building yielding an NOI of $100,000 is worth $2,000,000 to the 5% cap rate buyer but only $1,666,666 to the 6% cap rate buyer.
What was driving me nuts was that the cap rates that buyers would accept kept dropping, meaning, more importantly for my purposes, buyers would pay more money than made sense to me. When my buddy told me that higher prices were the result of a cap rate compression, what he was really saying was that the investment community saw investment real estate as a low-risk, high-reward asset class - to be purchased with less immediate return given its obvious upside potential.
Unfortunately, since about a year ago, the cap rate compression has turned into a cap rate decompression. Now, investment real estate is not viewed with the same rose-colored glasses that it was just a year ago. Instead of cap rates going down, they are going up, meaning that the typical investor will pay less for a property than he would have only one year ago.
What is happening is part of the de-leveraging of America's assets. Instead of lenders seeing the stability of asset classes like real estate, they are seeing only the risks. As a result they want more equity to secure loans. They want higher interest rates, more escrows and reserves and more stringent underwriting.
Between the de-leveraging and the cap rate de-compressing, most experts predict that we are in for a very tough 2009 when it comes to investment real estate.Jim Randel is the author of the just-released book, The Skinny on The Housing Crisis (Clover Leaf, 2008).
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