billddrummer

Commercial Real Estate Offering 8%-9% Cap Rates, Anyone Interested?

Hi Judy,

Thanks for this thread, excellent information!

The capitalization rate (cap rate) is a method for determining a property's value by discounting the income stream the property produces by a percentage. To compute a value, you take the income stream and divide it by the cap rate.

Here's an example. If a property generates $50,000 in annual income, and the cap rate is 4%, then the property's value based on the income stream is $50,000/4%, or $1,250,000. If the cap rate moves to 8%, then the property's value drops to $625,000 ($50,000/8%).

The comment above refers to the reality of the marketplace, where cap rates are rising because comparable sales are falling. Usually the cap rate is just a 'check' on a property's value--the biggest influence on value is what comparable properties sell for. So to generate demand, prices are falling, which pushes up cap rates if the income stream remains stable.

Cap rates can also change if the cash stream changes. In the example above, if the property generates $45,000 annually instead of $50,000, to get to a $1,250,000 value would require a cap rate of 3.6%--an extremely aggressive valuation. With softness in the commercial real estate market for virtually all property classes (industrial, retail, office, and special purpose), there's little incentive to overpay for a weaker income stream.

ATB,

Bill

Commercial Real Estate Offering 8%-9% Cap Rates, Anyone Interested?

NLI and EGI are identical. Both include adjustments for vacancies and credit losses, nonreimbursed property operating expenses, and provide a basis for determining cap rates, debt coverage ratios, cash on cash return, and property values based on both the actual and potential income streams.