As a commercial real estate agent with Keller Williams, I am asked by my clients almost daily as to what a property is worth or how to determine what a property is worth. To be able to know their clients and know their client’s needs and criteria is an important function of a quality commercial realtor. They must be able to perform the function of helping a client analyze a potential investment. This investment could be purely an investment or perhaps a new business location.
Over the next couple of months, I am going to write a series of articles regarding pricing of commercial property. We will discuss “rule of thumb” numbers and actually how to get down to the “brass tacks” of what the proper price is to pay for a property. You must keep in mind that price is different for everyone as everyone has different criteria as to what risk they’re willing to accept. A business expansion is no different as you certainly don’t want to pay too much. Hopefully in the end when you sell that business or retire, you can look back and see that purchase was a wise purchase.
CAP rates seem to be a big mystery for many, so this is where we’re going to start.
Everybody likes to know what a good CAP rate is for a project, but that really depends on your personal investment criteria and preferences. It also depends on what your outlook is for the future for the property and its location. A great commercial real estate agent is going to help you determine what the appropriate CAP rate is for the project you’re trying to do. The CAP rate is a tool to help you make good decisions.
Simply put, the CAP rate is a formula equaling the Net Operating Income (Income less expenses, but not all expenses) divided by the purchase price. The result is a percentage, such as 0.08% and often expressed as an “8 CAP” where the percentage is multiplied by 100. Now, how you look at income, as in actual, pro-forma, or considering future potential upside, needs to be considered. Also, not all expenses go into the calculation. Keep in mind that everyone does it a little differently. You need to work with your Commercial Real Estate Agent to look at it properly and per your preferences.
CAP rates are a basically a measure of risk. Generally, a higher CAP rate means an investment is riskier and a lower CAP rate means an investment is less risky. A CAP rate is a measure of the actual investment currently in this area. Several factors will come into play when determining the CAP rate. The TYPE of property affects the CAP Rate (think about a recently built apartment building versus one built 60 years ago and the risk that each one has to you). The MARKET in your geographical area affects the CAP rate (Rents in a big city are typically more than a small city, but building costs are too!). Finally, WORLD TRENDS and EVENTS. For example, are we in an economic shift or what do people want compared to what was wanted in the past (think of Millennials and home buying trends)? So, remember, CAP rates are a tool. You need to know your criteria, your area, your demographics, and so on. This is where a good Commercial Real Agent will help you!
There is a lot more to discuss here….so come back next month as I finish my discussion on CAP rates. I will be presenting some examples and discussing how CAP rates come into play. As always, feel free to contact me with questions!
– Christopher J. Mokler