Cap Rates NYC - are they compressing or increasing? Examples included
Hey guys,
So due to the pandemic have cap rates have come down or gone up?
Cap Rate Decease Example: Owner wanted $10 million pre covid and has a $500k NOI it's a 5 cap. Now during covid maybe he lost some tenants or leased space lower than expected and his NOI has come down to $400k. That's now a 4 cap because the owner wants to keep unrealistic pricing at this time and not adjust to the market.
- Is that thinking correct?
- For me this part is confusing because doesn't a lower cap rate usually mean more stability/safety/higher quality asset & tenancy/etc?
- Why would the same property with a lower NOI and potentially lower quality tenants warrant a lower cap rate?
Cap Rate Increase Example: I could also see cap rates increasing, wanted $10mm pre covid at $500k NOI, 5 cap. Now the same NOI, but people aren't willing to pay as much for the property and want a steal. Owner now says he'll sell for $8mm at same $500k NOI, comes out to a 6.25% cap rate.
- Confused because it seems the second scenario is more likely, but I was reading that cap rates usually increase due to interest rates (not the case), distress (may not be the case if this is a LT owner with no debt), building is not as in demand (definitely for NYC depending on asset class, lease expirations, vacancy).
Let me know your thoughts.
A value add deal can sell for a lower cap rate than a core deal. For instance, stabilized asset at $500k NOI, but you can’t increase revenue from there, you’re buying, in your example, a 5% yield.
but..
Let’s now say I can increase the NOI to $650,000 and current NOI is $400,000. Let’s also assume the current market cap rate is 5% and I don’t need to invest any additional capital above the $10,000,000 to purchase the building. I buy it at a 4% cap, and I raise NOI to $650,000, at the current market cap rate, the value of the asset is now $13,000,000. I am willing to pay a low cap rate as there is upside I can take advantage of. People generally look at the current market cap rate, and than figure out where the building’s cap rate (AKA yield on cost) can stabilize. This creates your profit at reversion (sale).
Yes, lower cap rates technically means less risky, but that’s why to do a risky deal, you need to be able to stabilize at some margin above the current market cap rate for a stabilized deals. When you see that the market cap rate is 5%, but a value add deal is selling for 4%, it basically means there is enough competition that someone is willing, in a sense, to pay extra to have the upside the asset can create. In a perfect world, everything would trade at a 5% cap rate and you wouldn’t need to pay for the upside-you would get to take advantage of it because you bought the building at a 5% cap rate.
In terms of have cap rates gone up or down - I don’t know if anyone really knows yet. There may not be enough transaction volume to figure it out quite yet.
Both of your scenarios above are likely. Everything is building dependent. You can’t just look at NOI and make sweeping generalizations. You need to know - what is the quality of the building, lease terms, market rental and vacancy rate, capital needs, etc. You also need to take into account - how hard will it be to complete the business plan and get the asset where it needs to go.
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