03 Oct InvestRE: Big 3 with Chris Cobb on CAP Rates
By Chris Cobb | Associate
Welcome back to the Big3 with CC, your weekly real estate investment source. A quick look so far at my Big3 college football teams; Florida, Navy, & Boston College. Great tough, fought, win at home by the Gators, another gut-check road game passed with flying colors by the Midshipmen of Navy, and an “expected” and much-needed win by the Eagles of Boston College. Pretty good Saturday if you ask me. I hope your teams had
Today we take a closer look at CAP Rates. Is it dark arts or hard science? How can we determine what the CAP rate should be for an investment property that is generating revenue?
Location, Location, Location
Like with most things in real estate, it comes down to the location of the subject property. Population, wealth, and education are usual suspects that drive Capitalization Rates in certain locations. That’s a Big3 within a Big3. Do you feel like you’re in the movie Inception yet? A city like New York or San Francisco will have lower CAP rates than say Charlotte or Mobile. This is not a knock on Charlotte or Mobile, in fact, higher CAP rates can sometimes mean a larger profit margin if you are buying a center. For example, buying a shopping center at an 11% CAP and selling for an 8.5% CAP (after some work) may be more profitable than buying a shopping center for a 7% CAP and selling for a 5.5% CAP. The drive of the local economy also gets factored in when examining a city for CAP rates.
Have you been following the Fed? They intend to raise rates at least one more time before the year is over. If interest rates increase, the cost of debt increases, net cash flow decreases, and property values decrease, causing a fluctuation in CAP rates. Unfortunately, as investors, we do not have control over this portion but it is vital to track what the Fed is doing or intends to do. Knowing that the Fed may raise rates in the next six months could diminish your return if you intend to flip out of an investment at a certain CAP rate within that time period.
Vacancy, Lease Rate, & Lease Term
These three go hand-in-hand-in-hand. In an ideal world, to get the best CAP rate possible, you would aim for 0% vacancy with long term leases from good credit tenants. As pieces of the puzzle are removed, the CAP rates should rise. When considering a shopping center or office space as an investment, make sure to check the vacancy of shopping centers and offices in close proximity to yours. If you are looking at a 40,000 SQFT shopping center and there is a 100,000 SQFT shopping center across the street that is 80% vacant, you may want to reconsider…
When it concerns real estate, invest yourself.