Would a hungry entrepreneurial real estate investor that really needs to gain traction with investors look at a 5% cap rate as attractively as a very wealthy established owner with a lot of real estate?
The established owner is going to look at 5% from their vantage point of wanting to preserve risk. Is this a low enough chance of risk to feel comfortable that they are not going to lose money? In their situation, they do not need to make a lot of money. They will take a lower risk. On the other hand, the hungry investor may be on the look-out for something a little less comfortable that may create an 8% return of their investors who are seeking higher returns. For this investor, the 5% is not enough.
To share another example, a property may be the only property not owned by a sole owner who owns all of the other buildings on the street. To the owner, a 5% cap rate may sound really cheap! They may take a 2% capital rate of return because they could average it with all their other buildings as they now own the whole street. This investor might even pay $20 million instead of $10 million to take on the 2%.
This is how markets are established. You have groups of buyers establishing the what, the why and to whom. When a decision to sell a property is made, the property may be sold at market value or the sellers may choose to wait until the right buyer comes along who pays above market price, because to them, it’s a good deal.
At BrandView, we specialize in weighing up all of these factors to find what is a good margin for our investors. The financial analysis of a property may state that the cap rate has a 5% return. Well, is there a path that could be taken to create a 10% return? How much risk and execution is in that path and what do you have to believe in to achieve it? We’re always trying to create new avenues and extensively look at different deals and all of the associated paths for creating value on a property.
Components of Value
Value is based on your discount rate. A component of your discount rate of return is the risk and the way to assess the risk of a property is really three things: permitting, design and market. Is there a market for what this building is trying to do? From there, are the associated costs with the design and permitting feasible? And lastly, is the financing feasible, which means is there a source of debt and/or equity for this type of bill?
Read next…”Pro forma Valuation Approaches”