comfortable cap rates ?

[Norman Ashworth]

What do you guys consider a comfortable cap rate with a first purchase ? A small 3-4 unit strip mall , fully leased . recent upgrades and maintenance completed.

Should not need much work going forward but i will have it looked at.

I am looking at a couple, maybe three as cash flow. Do you actually "net" the cap rate ? Or is that just the commercial realtors pitch !!

appreciate your knowledge,
normana61

[John Hostetler]

You will get better, more informed responses than mine soon enough, but one thing I know for sure: NEVER count on the seller’s claimed cap rate as a basis for your purchase. They will, in 99.9% of listings I have seen, understate true expenses to get to their claimed cap rate. Even if they show you “actual†expenses, these are short term numbers and will usually not include allowances for capital expense outlays which all properties will encounter, such as roofing, HVAC, plumbing, electrical. Etc.

CRE is a different animal, and I do not know if the “50% rule†applies (**please do a search on BP for this critical info**) as it does to residential. But make sure you are realistically estimating your ongoing costs if you plan to hold a project long term. These include, at least:
Taxes (which may be much different once the property is re-assessed after purchase)

Insurance
Vacancy allowance (which WILL occur)
Property Management
Utilities
Repairs / Maintenance (which includes those pesky capital expenditures)

Now, that said, the “cap rate†is a return on the investment without regards for financing. This means that once you come up with a realistic Net Operating Income based on the good estimates for all of the above expenses, the cap rate is the NOI divided by the entire cost of the project. If you pay cash for the property, then this is your expected return. But if you finance a significant portion of the property, then the return on your money can be quite different than the cap rate.

For a simplified example, if the property costs $500K and the gross rents are $100K per year, and expenses are 50%, the NOI would be $50K and your cap rate = $50K / $500K, or 10%. Now, if you borrow $350K of this at 6% interest, your actual investment is $150K and your cash flow will be reduced by the amount of P&I payments of the loan, which come to just over $25K per year. So, although your cash flow is reduced from $50K down to $25K, the return on investment is based on a much smaller investment of $150K instead of $500K. Thus your cash on cash return is actually $25K / $150K, or 16.7%

Like I said in the beginning, I am no expert. But I have learned a ton on this site, so I encourage you to garner as many opinions as possible. The BP Nation is sure to correct any flaws in my analysis above!

Good luck!