So the title kind of says it all. I know a typical spread is usually about 50-bps. However, I was curious as to if someone could kind of give a high-level overview of some scenarios that might warrant a 25-bps spread, or a 75-bps spread.
FYI, I'm an analyst at valuation/advisory firm.
Any insight would be greatly appreciated.
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The biggest one to keep in mind is the deal related risk - given your 50 bps spread I am assuming this is stabilized, core product. As you move further up the risk spectrum into value add and opportunistic/development deals that spread increases to account for the additional risk you are taking on as the buyer.
Several other reasons besides that which would drive a higher spread include future buyers’ view of the market and projected interest rate movement. If there is a clear, demonstrable trend that the city/region will stay on a continued strong growth path then buyers will likely be willing to pay more for those properties relative to today’s conditions.
Financing costs come into play if there is a strong indication in the future that interest rates will go down. Buyers will be willing to pay more for properties as they can usually obtain more leverage and pay less while maintaining their cash on cash returns.
Keep in mind that I am interpreting your question as to why exit cap rates would tighten in the future (getting reduced resulting in higher sale prices) thus expanding the spread - not why you would pay less going into the deal.
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