The Overall Capitalization Rate • Section 14 T
he overall capitalization rate or “cap rate” is used to con- vert income to value. One of the easiest ways to think of the relationship of a cap rate to value is the acronym IRV:
Income divided by Rate = Value or I/R = Value. As the cap rate goes down, the value goes up. Officially, the direct capitaliza- tion is defined by The Appraisal Institute in the Dictionary of Real Estate as follows (page 65):
It is also important to understand if expenses were adjusted to market, particularly real estate taxes, in the forecast or stabilized cap rate.
“A method used to convert an estimate of a single year’s in-
come expectancy into an indication of value in one direct step, either by dividing the net income estimate by an appropriate capitalization rate or by multiplying the income estimate by an appropriate factor. Direct capitalization employs capital- ization rates and multipliers extracted or developed from market data. Only one year’s income is used. Yield and value changes are implied, but not explicitly identified.”
To complicate matters, a cap rate
can be calculated on last year’s net op- erating income (often called trailing), a forecast of next year’s expectations of net operating income (forecast). Moreover, the “true” cap rate is often a perspective, not a fact. For example, the seller may believe the cap rate was a 5.5 percent, implying a higher value, while the buyer may believe the cap rate was a six percent, implying a high- er return. And, the broker involved in the deal may report a 5.75 percent cap rate. While all three perspectives are important to understand, it doesn’t ex- actly determine the cap rate.
For comparison purposes, it is best to
understand the forecast or stabilized cap rate (for example, this is the cap rate used in an appraisal) and the trailing cap rate to un- derstand expectations of buyers and sellers in the transaction. It is also important to understand if expenses were adjusted to market, particularly real estate taxes, in the forecast or stabilized cap rate. For the purposes of this section, the stabilized or forecast (sometimes called Year 1) cap rate will be addressed because it is typically the most consistent cap rate considered for
1 1987 2
3 1978 4 1974 5 1977 6
Low Cap Rate High Cap Rate
Average (Mean) Cap Rate: Source: Compliled by NKF
PwC Real Estate Investor Survey: 1st Qtr. 2018 PwC Real Estate Investor Survey: 3rd Qtr. 2018 PwC Real Estate Investor Survey: 1st Qtr. 2019 PwC Real Estate Investor Survey: 3rd Qtr. 2019 NKF Self Storage Investor Survey: 3rd Qtr. 2019 PwC Real Estate Investor Survey: 1st Qtr. 2020 PwC Real Estate Investor Survey: 3rd Qtr. 2020 NKF Self Storage Investor Survey: 3rd Qtr. 2020 Source: Compliled by NKF
comparison purposes (for example, it is the basis of Investor Surveys on cap rates).
Capitalization Rates And Techniques To understand the cap rate, four techniques will be analyzed: direct cap comparables, two mathematical models called the Band of Investment and the Mortgage Equity Technique or Akerson format, and Survey Research.
• Direct Cap Comparables – Deriving comparables from similar properties that have sold is generally the pre- ferred technique when sufficient information is available. For example, what cap rate is reported? The trailing or the stabilized? Comparable cap rates are summarized in Table 14.1.
These properties are all stabilized economically (at least
three years of operating history with stabilized physical and economic vacancy) and reflect Class-B assets. The primary variance is economic characteristics that can be simply mea- sured in terms of NOI/SF of rentable area. The range is 124 basis points (bps), suggesting a large range. Bear in mind, this underscores how important it is to understand the per- spective of the person verifying the cap rate. And these cap
Jun-2019 Jul-2018 Apr-2018 Oct-2019 Jan-2020 Mar-2018
2000 1983
10,135 56,780 36,925 44,495 70,590 55,218
95% 80% 97% 92% 96% 96%
$133 $139 $108 $111 $172 $124
5.70% 5.00% 5.79% 6.12% 5.27% 6.24% 5.00% 6.24% 5.69%
4.50% - 7.00% 5.65%
4.50% - 7.00% 5.66% 4.50% - 7.00% 5.66% 4.50% - 7.00% 5.75% 4.50% - 8.50% 5.60% 4.50% - 7.00% 5.67% 4.50% - 7.00% 5.68% 4.50% - 8.50% 5.50%
2021 Self-Storage Almanac 129
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