How to objectively determine CAP rates in a market / sub-market?

Question

Is there an objective resource to use to determine the CAP rate for a commercial multi-family property? I want to be armed with better information than just what the seller's agent is providing me. I'm not finding a lot of tools that I can use, and even looking at recent sales may not give me enough info to back into the CAP rate unless I happened to also have the P&L info for the property.

Your thoughts are greatly appreciated!

Jonathan Orr · Answer

@Jeff Owen I am sure you know that CAP rates are determined by dividing your NOI over PURCHASE PRICE. You can then back into a CAP rate or if you want to determine a price via cap rate then divide NOI by your CAP rate. To find cap rates, that is determined by the market (look on loopnet, local brokers for comps, etc...). If you are trying to find where your local cap rates are trending, CBRE put out a nationwide average cap rate for different asset classes in top 20 cities, that may be a good start.

To do all of this, as you mentioned you need to have a P&L on the specific property. Prior to writing a LOI or making any offer the owner or broker should provide you with that P&L. If they wont provide you a Trailing 12 P&L (big red flag).

Hope this helps

To do all of this, as you mentioned you need to have a P&L on the specific property.  Prior to writing a LOI or making any offer the owner or broker should provide you with that P&L.  If they wont provide you a Trailing 12 P&L (big red flag).

Hope this helps

Tj Hines · Answer

@Jeff Owen you can vet the broker you're working with with other brokers in the area. Simply ask brokers who specialize in that type of asset for that area " at what cap rate are buildings trading for similar to this asset in the area?" Ask a few brokers. You should have a good idea of what cap rates on buildings like yours are trading for. You can even track down local property managers that specialize in the asset with those amount of units of what properties like this are trading for as well. Finding out the price per door properties are trading for is just important.

Kent Ritter · Answer

@Jeff Owen as everyone has said cap rates can be difficult to lock down especially in smaller markets. I recommend focusing on the return you expect and using that to determine the price you will pay vs. trying to stick to a certain cap rate.  If you know you want a 10% cash on cash and the investment will give you that then that is all that matters.  Especially on a value-add deal the entry cap isn’t as relevant as the exit cap.

Ben Leybovich · Answer

Jeff, the most objective way is to make offers. Each time you make an offer, you are saying:

I will buy this thing, so long as I can achieve x% return.

If you keep missing deals, then you know that other people are willing to deploy at a lower cap rate, at which point your choice is to either sharpen your underwriting or to stop trying.

Can't get more objective than that :)

Jeff Owen · Answer

Thank you all for the feedback.  I understand the calculations in determining the CAP rate or calculating the purchase priced based on the NOI and CAP rate.  I'm more trying to validate that what the broker is suggesting is a fair CAP rate so I can determine a purchase price based on the NOI.  I'm trying to avoid over-paying for the property by not having enough information to validate the CAP rate.  I can look on LoopNet, but I think I can only see what is for sale.  I cannot see what has sold, I don't believe, or necessarily for how much or what the P&L was associated with the sale.  That's a great idea, regarding reaching out to some property managers and other brokers in the area.

Bjorik Mutize · Answer

Also look at historic cap rates in your market

Greg Dickerson · Answer

Market CAP rates are set by the buyers. A property is worth whatever someone is willing to pay. There are averages that properties trade for in certain areas for the different types and classes of property but at the end of the day it's really what works for the buyer. The higher the demand the lower the CAP less demand Higher CAP.

Peter Tiberio · Answer

@Jeff Owen Cap rates in smaller areas away from major cities can be tough. I can't say I know Franklin, TN but that's what makes me think it's a smaller city with not many small multifamily building transactions. My advice would be to be similar to what Johnathan said and find the nearest city that you feel has a cap rate that you're comfortable determining and then from there discount or add a premium to the cap rate of your city and then your neighborhood.

How to objectively determine CAP rates in a market / sub-market?

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