Self Storage- Cap Rate and/or Value Add discussion

[Henry Clark]

Was on another post and cap rate was really being discussed heavily, in terms of how many good deals are not out there, due to Cap Rate compression. If an REI investment arena was to ever use Cap Rate it would be self storage. But we don't use it. We analyze deals based on an 8 to 12 year payback; with a loan amort period of 20 or more. This does not include value add potential since, I would be paying the current owner for improvements that I would be doing.

Can Cap Rates be used to analyze properties, I guess so.  But to me only to the following degree:  

When I want to go catch Red Snapper I look for Salt water, not fresh water.  That to me is the level of use of Cap Rates looking for a deal.  You might use at a macro standpoint, but I wouldn't even do that.  You have to look at the details as shown below.

I am using the Self Storage arena for the following discussion. There might not be as many variables or potential in the SFH and MFH world, but still the same concepts.

Same property, same market, same everything except the following:

                                                     Option 1:                Option 2:    How???????????????
Selected P/L items:

Rental deductions                             $20,000                 $5,000             ??????

Property Tax                                     $30,000                          0            ??????

Insurance                                          $10,000                         0             ???????? 

Electric                                             $12,000                         0            ????????

Auto                                                  $ 6,000                          0           ????????

Management                                      $20,000                         0           ????????

Snow/Landscaping                             $   4,000                        0           ????????

Advertising                                        $20,000                         0           ????????

Net Operating Income                        $100,000             $207,000

Property Market Value $1,500,000 $1,500,000 Yes, Market value would go up as NOI increases, left the same for discussion, you can adjust to $3,089,000 new NOI value at 6.7% cap.

CAP rate 6.7% 13.8%

All of the above tactics, positions, decisions, situations are legal and easily executed. But see the big swings in CAP rate, and in turn potential Market Value. Some of these are "timing" and others are permanent.

If you respond, please address the following:

A. Where and from whom do you get your CAP rate figures?

B. To what degree do you analyze the CAP rate figure?

C.  How would you move the above figures or how could they move without your efforts?  They could go up or down in your scenario.

Don't trust me or the Cap Rate figure.  Do your due diligence.  Because if I'm selling to you, I want your money.

There is a tool or metric for everything, make sure you're using the right tool.