RE Acquisitions Monkeys - How to ascribe a Cap Rate to an Asset
**This discussion is meant to be a starting point for new monkeys who could find it useful to their understanding of acquisitions and valuations.
**
As the title asks, how do you, as an acquisitions professional, attribute a cap rate to an asset that you're looking to purchase.
Specifically, what's your thought process when valuating a stabilized vs unstabilized vs ground-up development?
Some Key Thoughts / Drivers
- Risk-Free Rate (US Treasuries)
- Spread above Risk-Free Rate to compensate for risk of future cash flows
- Cost to get asset to stabilization
- Expectations of Rent Growth or Submarket Economic Growth
- Cost of Financing
Some Questions
- Similar Asset in Different Cities - What's driving Valuation / Cap Rate Difference?
- Different Product Type in Same City with similar growth expectations - What's driving Valuation / Cap Rate Difference?
Would add an additional driver: Execution Risk, which doesn't really fit into #3 above. For example, buying an affordable stabilized asset limits future rent growth, but if I'm guaranteeing myself cap rates today, that's worth something.
Goal seek
From my point of view ,a property that’s valued at $1 million and has an NOI of $100,000 would have a cap rate of 10%. A property that’s valued at $500,000 with an NOI of $25,000 would have a cap rate of 20%. A higher cap rate usually indicates a greater degree of risk and, typically, a higher expected return.It is critical for prospective investors to understand the specific assumptions that are built into the NOI figures as presented.
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