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- Jul 24, 2007
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The following is an excerpt from an article at Torto Wheaton. You will likely need to join them in order to read the full article but they have some worthwhile information: https://www.twr.com/default.aspx?_title=AboutRealEstate&_id=1622
One thing I have found is that you can always find articles and information to support what you wish to believe.
Without a doubt, there has been some cap rate compression. I have felt for a while that cap rates will climb. I also agree that they will tie into the lending environment and interest rates.
Where we disagree is the magnitude and the ensuing issues around it. I do feel that job growth and retail spending have slowed enough to do some damage to the office and retail commercial fields. There has been a significant amount of overbuilding in some areas to go along with this. I would not buy into these sectors for a while myself.
Apartments are still a different animal. Many areas are still showing improvements in occupancy coupled with rent growth. This is what I hang my hat on. A rise in cap rates can be overcome with strong fundamentals. If the fundamentals for the area are strong enough, a significant increase in cap rates is unlikely. In fact, downward pressure usually occurs in improving areas.
I have and will continue to factor in cap rate fluctuations in my analysis. It is important to look at the downside potential as well. All investments have some risk to them.
The idea that a cap rate must be in double digits is very limiting in my opinion. That would limit me to geographic locations and parts of town that are of less interest and typically have less upside potential. If you note the cap rate quote in the article it states them at 4-5%. I have hit home runs with properties that are less than 5%. Granted, my pro forma showed a strong 7.5% with improved financials.
There is no harm in waiting if that is what your data tells you to do. My plan is still wrapped around buying underperforming properties in improving areas. I like the national demographic for renters over the next few years. A slowdown in development would be very welcome in supporting more growth in the rental market.
The 3rd quarter results for cap rates show that capitalization rates for the various property sectors have stayed at roughly the same level (between 4% and 5%) nationally over the last three years. During that time, commercial property markets experienced extreme cap rate compression, which is considered out of line with the long-term trend in the market. On cursory examination, the stability in cap rates into the 3rd quarter might appear counterintuitive, since financial market volatility increased significantly during the same period as a result of the subprime mortgage troubles. Given this increased financial market volatility and uncertainty in the debt markets, one might have expected strong increases in cap rates.
This analysis demonstrates that the flat trend is due to inertia from rent growth that was in place before the subprime crisis hit. This residual rent growth has been counteracting the negative effects of market volatility, keeping the cap rates at the same level.
One thing I have found is that you can always find articles and information to support what you wish to believe.
Without a doubt, there has been some cap rate compression. I have felt for a while that cap rates will climb. I also agree that they will tie into the lending environment and interest rates.
Where we disagree is the magnitude and the ensuing issues around it. I do feel that job growth and retail spending have slowed enough to do some damage to the office and retail commercial fields. There has been a significant amount of overbuilding in some areas to go along with this. I would not buy into these sectors for a while myself.
Apartments are still a different animal. Many areas are still showing improvements in occupancy coupled with rent growth. This is what I hang my hat on. A rise in cap rates can be overcome with strong fundamentals. If the fundamentals for the area are strong enough, a significant increase in cap rates is unlikely. In fact, downward pressure usually occurs in improving areas.
I have and will continue to factor in cap rate fluctuations in my analysis. It is important to look at the downside potential as well. All investments have some risk to them.
The idea that a cap rate must be in double digits is very limiting in my opinion. That would limit me to geographic locations and parts of town that are of less interest and typically have less upside potential. If you note the cap rate quote in the article it states them at 4-5%. I have hit home runs with properties that are less than 5%. Granted, my pro forma showed a strong 7.5% with improved financials.
There is no harm in waiting if that is what your data tells you to do. My plan is still wrapped around buying underperforming properties in improving areas. I like the national demographic for renters over the next few years. A slowdown in development would be very welcome in supporting more growth in the rental market.