What’s the Cap?
One of the most important qualities of an effective broker is the ability to be objective. This can be challenging as brokers often operate between presenting an attractive proposal and following appropriate market pricing guidance.
Pricing guidance is determined by three factors: current in-place cap rate, effective cap rate, and stabilized pro forma cap rate. In this article, we’ll review a case study of one of our recent sales and discuss how each cap rate affects pricing.
Deal Highlights:
- Occupancy: 92% physical, 83% economic
- Expense load: 23%
- Secondary market, strong demographics
- Market surplus
- Class B prefabricated steel, non-climate
Good: Our seller is motivated, and this is a well-leased facility in a steady market with average rates.
Bad: For this deal to pencil, the sale needs to occur in a cap rate range where they can service debt, pay out preferred return, and grow the stabilized cap rate.
Even if a seller can efficiently operate with in-place expenses significantly below market, a lender/buyer will underwrite the deal between a 32-40% expense load, affecting all three cap rates. The solution is to grow rates while holding occupancy resulting in a revenue boost that outweighs any expense increase.
Metrics:
- List Price: $3,375,000
- In-place NOI/Cap: $257,265 / 7.62%
The low expense load impacts this deal, highlighting the importance of the effective cap rate versus the in-place cap.
Effective Cap Rate calculation (trailing 12-month revenue-pro forma expenses) / (purchase price)
- Forward-looking expense load: 32%
- Effective NOI: $227,061
- Effective Cap: 6.7%
Given the stabilized nature of the deal, limited upside, and subtle supply concerns, we estimated month-24 revenue growth would top out around 17%, bringing our metrics to:
- Stabilized Year 2 NOI: $265,818.62
- Stabilized Cap: 7.8%
Our 24-month NOI growth was only 3.32%, however, we saw a 17% increase from the effective NOI to stabilized.
In late 2022, an in-place 7.6% cap would typically be unattractive to a seller, however the true cap is in the mid-6% range. This deal, having limited upside and a low DSCR, lends itself to a higher in-place cap rate, but lower spread between in-place cap and stabilized cap rate.
As a broker, my job is to educate parties on cap rate fluctuations affected by deal-story and current property performance. Arbitrarily using market cap rates without proper analysis is a dangerous practice that can lead to poor evaluations.
Please reach out directly for more information on which cap rate is most relevant for your specific asset.
Contact:
Hunter Molnar
Co-Founder & Managing Director
hunter@storageexchange.com
