The Use and Selection of Cap Rates
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Basic Cap Rate Valuation
Cap Rate Calculation Cap Rate = Stabilized NOI/Value = 1/Multiple Multiple = Value/Stabilized NOI = 1/Cap Rate Value = Multiple*Stabilized NOI = Stabilized NOI/Cap Rate Note an "8 cap" = .08 = 8% = 12.5 Multiple
Cap Rate Calculation Cap Rate = Stabilized NOI (yr 1)/Value Value = Stabilized NOI (yr 1)/ Cap Rate
Summary Information Yield on 10 Year T Note Risk Premium Cap Rate Multiple NOI Valuation With Cap Rate With Multiple 3.60% 100 basis points (bp) 3.6%+100bp = 4.6 1/.046 = 21.7x $3MM 3/.046 = $65.2MM 3 * 21.7 = $65.2MM
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Gordon Growth Model: Simple Cap Rate Estimation
Growth and Discounting* Value = (NOI) / (discount rate – growth rate) = NOI/Cap Therefore: CAP = (r - g)
*Unless stated otherwise assume Stabilized NOI
Summary Information Discount Rate Growth Rate Gordon Calculation Multiple Cap Rate 4.6% 1.0% 1/(.046-.01) = 27.8 27.8x .046-.01 = .036 = 3.6%
Summary Information Discount Rate Growth Rate Multiple with growth Multiple with no growth NOI this year Valuation NOI next year With Multiple and growth With Multiple and no growth 5.6% 1.0% [1/(r-g)]=1/(.056-.01)=21.7x [1/r]=1/.056=17.9x $3 MM $3 MM * 1.01 = $3.03 MM 3.03 * 21.7 = $65.8 MM 3 * 17.9 = $53.7 MM
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Market Today
Description Office: Downtown office, prime towers, well located, well designed, top of the market, big building, lots of quality tenants, smooth lease expiration Office: Suburban, good, smaller, fewer tenants, not as well located, not quite as liquid. Office: Second tier city, suburban, small, two tenants, medium quality credit tenants, less liquid, lumpy lease expiration Comment: There is a large spread on the second tier office buildings. The city in which the property is located will have a significant impact on the property’s cap rate. Garden Apartments (A quality): Good location, recent design, (less visibility because no individuals will have credit, but the group does– these are individuals not companies occupying) Garden Apartments (B quality): Usually has a good market Garden Apartments (C quality): Usually has a good market Comment: There is a significant increase in the cap rate for lower quality, B and C, properties. Cap Rate 7-8 7.5-9 8.5-12
7-8
8-9.5 9-12
Shopping Centers (A): Good supermarket anchored tenant with Wal-Mart already in the competing market, so no fear of sudden entry and decline in customers Shopping Centers (B): Pretty good strip center Shopping Centers (C): Empty Kmart, not well located Warehouse: Great location, near a major highway or exit ramp that leads to the property with ease. Warehouse: Poor location, no easy access to the highway Hotels: Hotels are incredibly difficult to value in this market.
7.5-8.5 8.5-11 10-14 8-9.5 9-12 n/a
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A Look at the Past
4% 2% Cap Rates 0% -2%
19 78 19 2 79 19 2 80 19 2 81 19 2 82 19 2 83 19 2 84 19 2 85 19 2 86 19 2 87 19 2 88 19 2 89 19 2 90 19 2 91 19 2 92 19 2 93 19 2 94 19 2 95 19 2 96 19 2 97 19 2 98 19 2 99 20 2 00 20 2 01 20 2 02 20 2 03 20 2 04 2
Apartment Retail Industrial Office
-4% -6% -8% -10% -12%
Year-Quarter
200 150 $ Billions 100 78 50 0 -50 -100 1987 1989
-20 -55 -38 97 75 31 3 4 42 22 1 23 1 1 39 48
1 62
1 80 1 50
1991
1993
1995
1997
1999
2001 2003*
Source: Federal Reserve Bank; *Mid year seasonally adjust ed annual rat e
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