Wednesday, October 28, 2009

Big Numbers Don’t Tell the Whole Story: Cap Rate Averages

Cap rates are going up nationwide, but accepting this notion as all encompassing does disservice to a market filled with tenant disparity. If one surveyed the nation they would undoubtedly find properties which are suffering, as well as those who continue to prosper. Though the big numbers say cap rates are going up, buyers shouldn’t scoff at properties with low cap rates. They may well deserve them.

Take a case involving an Arby’s (NYSE:WEN) for example. Recent sales have had cap rates as high as 10.07% and 14.85% and Arby’s has posted an average rate of 8.40% over the past six months. So if an owner tried to market one for 7.50% to 7.75%, one would have to wonder what he was thinking, right? But go back to Rules 1-3 of real estate: it’s Location, Location, Location. If that Arby’s happens to be located in the DC metro area surrounded by affluent suburbs, the property would require a much different valuation than the overall numbers would project. A property with the right location can be worth the low cap rates; even if nationwide they are rising.

Real estate is not like an automobile. A car in Washington D.C. is going to be the same as one in Wyoming. However, a property in Washington D.C. will be radically different (value wise) than that of Wyoming. Though the lure of high cap rates may be great, their applicable properties may not be deal they appear to be. Would you rather have a high cap rate property in Wyoming or one with a lower rate in the D.C. area? Certainly it would depend on the investor but it would be prudent to keep in mind the oldest rule of real estate when making deals in this brave new world.

1 comment:

  1. Maybe if you pay cash for that Arby's, you can afford the low cap rate. Cap rates had become completely unhinged from reality over the past few years and the 4th rule of RE is don't pay a cap rate that is lower than your mortgage constant. In this market, that rule trumps 1-3.

    I guess if you have an IO conduit loan then by some reckoning you don't have a mortgage constant, but of course, those aren't flying off the shelves like they once were.

    The point is that you have to know your financing parameters even if you are paying cash and refinancing later. A cap rate is an actual mathematical value not a sentimental one.